Getting Active With A Financial Services ETF

Financial services stocks and exchange traded funds remain out of favor with many investors and with interest rates poised to decline further, which weighs on banks' net interest margins, some investors may be inclined to stay away from the third-largest sector in the S&P 500.

What Happened

Those that are considering the sector may want to put active management on their something, which can be done with the Davis Select Financial ETF DFNL, an ETF that's up more than 12% this year.

DFNL is the ETF descendant of the Davis Financial Fund, a well-known financial services mutual fund that “delivered an average annual return of 11.32% from its inception on May 1, 1991 through June 30, 2019 versus a return of 10.66% for the Lipper category average,” according to the issuer.

Why It's Important

Chris Davis, chairman and portfolio manager at the eponymous firm, notes that financial services names are currently out of favor with and underappreciated by investors. That scenario can actually be attractive to long-term investors.

“The biggest hurdles to investing in financials in this environment are psychological and emotional as investors still remember the aftermath of the 2008 financial crisis,” said Davis in a note. “While the overall market has more than doubled since then, financial stocks have not appreciated as much—even though select financial companies are delivering record earnings and have the strongest balance sheets in decades.”

DFNL holds 27 stocks, a somewhat focused lineup relative to some passively managed financial services ETFs. Top holdings in the fund include US Bancorp USB, Berkshire Hathaway Inc. (NYSE: BRK-B) and Dow components American Express AXP and JPMorgan Chase JPM.

“In addition to the current cyclical opportunity, we believe a strong case can be made that the right financial company is by its nature a long-term cash-compounding machine,” said Davis.

What's Next

Broadly speaking, financials are cheap relative to the broader market. As Davis notes, the S&P 500 trades at 16.7 times earnings and just four sectors are below that with financial services easily being the lowest at a price-to-earnings ratio at 11.7 times. Long-term data indicate DFNL's style could be a winner for investors.

“Investing in stronger companies and avoiding weaker ones can make a significant difference over time. Because the returns of financial stocks are widely dispersed, selectivity is key. In fact, since 2005, the average difference between the best and worst performing financial stock in the S&P 500 Financials Index has been about 132%,” according to Davis.

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