Bank ETFs Could Disappoint

When it comes to sector-level bets on rising interest rates, many investors believe the best place to go is to financial services. Indeed, the second-largest sector weight in the S&P 500 is home to some industries that are positively correlated to rising Treasury yields. Insurance providers and regional banks come to mind.

Data suggest investors are comfortable betting financial services stocks and exchange-traded funds will positively respond to the Federal Reserve's efforts to boost interest rates this year. For example, the Financial Select Sector SPDR Fund XLF, the largest financial services ETF, has gathered $1.27 billion in new assets this year, good for one of the best totals among all sector ETFs.

XLF is up almost 6 percent this year and resides at multi-year highs, but investors should be careful if they are expecting the Fed to truly lift this and other financial services ETFs going forward.

Expert Commentary

“According to Sam Stovall, Chief Investment Strategist at CFRA, during rising-rate periods since 1970, the S&P 500 Financials sector has traditionally underperformed the S&P 500. He cited the -0.70 correlation between Fed funds rate and the yield curve (10-year yield minus the Fed funds rate), meaning that when short-term rates rose, the difference between long and short rates fell as inflations fears lessened,” said CFRA Research in a note out Wednesday.

Up 5.5 percent year-to-date, the PowerShares KBW Bank Portfolio KBWB is another bank ETF generating interest among investors. KBWB differs from XLF on several levels. First, KBWB does not hold insurance companies. Second, the PowerShares ETFs does not feature among its 24 holdings dedicated capital markets firms.

KBWB has “$980 million in assets, pulled in $311 million of new money year to date through Feb. 17, according to data on etf.com. At the end of January, assets were primarily split between diversified banks (42 percent of assets) and regional banks (41 percent), with smaller stakes in asset management & custody banks (11 percent) and consumer finance companies (4 percent),” said CFRA.

CFRA has an Overweight rating on XLF and a Market-Weight rating on KBWB.

Disclosure: Todd Shriber owns shares of XLF.