KCE SPDR S&P Capital Markets

The financial sector has pumped up profits this year thanks to an improving job market, recovering housing fundamentals and increasing consumer confidence. Though Q3 was not as strong as Q2 due to disappointing performance by Goldman Sachs (GS) and J.P. Morgan (JPM), it generated solid earnings growth of 9.9% with a beat ratio of 58.2% (read: Financial ETFs in Focus on Earnings).
 
In fact, the broker-dealer/capital markets segment is leading the way higher in the broad financial sector with 22.7% earnings growth in Q3 and the trend is likely to continue to close out 2013. This corner of the market has already suffered the Fed’s ‘no taper’ shocker but is again drawing interest as speculations of a stimulus cut soon have resurfaced.
 
The segment is expected to be the clear beneficiary of this policy. This could be especially true for banking institutions as a steeper yield curve would lead to more money from a wider spread between short-term rates for deposits and longer-term rates for loans.  
 
In addition, greater volatility in the markets would help asset managers to bring in more capital, while many of the exchanges like ICE, NYSE or CME would benefit from more financial market activity. This suggests bullish trends all around for the space, in particular the broker-dealer/capital markets segment (read: Top Ranked Financial ETF in Focus: VFH).
 
Given these promising trends in the space, investors could take a look at the following ETFs for their exposure to the financial sector. Any of these could be an interesting choice as long as the taper is discussed or if it is actually implemented.
 
PowerShares KBW Capital Markets Portfolio ETF (KBWC)
 
This ETF follows the KBW Capital Markets Index, which measures the performance of these companies that do business as broker-dealers, asset managers, trust and custody banks or exchanges. It has amassed about $9 million in its asset base while volume is very light, probably increasing the total cost for this unpopular fund beyond the expense ratio of 0.35%.
 
With holdings of 24 stocks, the product is slightly concentrated in its top 10 holdings as it puts 59.4% of assets in them. Morgan Stanley (MS), State Street and Goldman Sachs occupy the top three spots with a combined 26.3% share in the basket.
 
The ETF has added about 40% year-to-date and currently has a Zacks ETF Rank of 2 or ‘Buy’ rating, with a ‘Medium’ risk outlook (read: 3 Surging Financial ETFs Beating the Market).
 
SPDR S&P Capital Markets ETF (KCE)
 
This fund tracks the S&P Capital Markets Select Industry Index, holding 53 stocks in its portfolio. Asset management & custody banks take the top position in the basket at 63.51% while investment banking & brokerage takes the remaining share in term of the industry profile.
 
With respect to holdings, none of the securities make up more than 3.36% share, suggesting spread out exposure. Further, the fund is widely diversified across various market spectrums with large caps accounting for 37%, small cap at 36% and mid cap at 25%.
 
The product manages assets worth $76.3 million in AUM while average volume is relatively light. The ETF charges a low fee of 35 basis points a year.  
 
The ETF is up 37.4% so far this year and has a Zacks ETF Rank of 3 or ‘Hold’ rating, with a ‘Medium’ risk outlook.
 
iShares Dow Jones US Broker-Dealers ETF (IAI)
 
This fund provides exposure to the investment services segment of the broad U.S. financial sector by tracking the Dow Jones U.S. Select Investment Services Index. The product currently holds 23 securities and invests around 59% of total assets in its top 10 holdings. GS, MS and Schwab Charles (SCHW) occupy the top three positions in the basket.
 
The ETF is appropriate for investors looking to get exposure to brokerage firms, dealers and other facilitators directly involved in the capital markets. The fund has accumulated $154.5 million in AUM while it sees good volume of nearly 80,000 shares a day. The product charges 45 bps in fees per year from investors (read: Why IAI Is a Great Financial ETF).
 
IAI had a strong run this year, gaining nearly 51% in the year-to-date time frame. The fund currently has a Zacks ETF Rank of 2 or ‘Buy’ rating, with a ‘Medium’ risk outlook.
 
Bottom Line
 
These three products have clearly outpaced the broader S&P Financial Select Sector SPDR Fund (XLF) and SPDR S&P 500 (SPY) by wide margins and show room for further upside (see: all the Financial ETFs here).
 

 
Any of the three may be a lucrative pick if the economy continues to improve and if the Fed starts scaling back its asset purchases. Further, any pickup in initial public offerings, mergers and acquisitions, trading and asset management resulting from a strengthening economy would support continued growth for this in focus industry which may have more room to run.
 
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GOLDMAN SACHS (GS): Free Stock Analysis Report
 
ISHARS-US BR-D (IAI): ETF Research Reports
 
JPMORGAN CHASE (JPM): Free Stock Analysis Report
 
PWRSH-KBW CMP (KBWC): ETF Research Reports
 
SPDR-KBW CAP MK (KCE): ETF Research Reports
 
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