A Year After Lehman: Are Financial ETFs Ready For Their Close-Up?

One year ago today, Lehman Brothers collapsed and sent the entire financial system and its related exchange traded funds (ETFs) on a downward spiral. Today, the picture looks much different. Are financial ETFs ripe for the picking?

Since the market lows on March 9, financials have rebounded handsomely, up as much as 140% since then. Most of them are perched firmly above their 200-day moving averages, as well.

There are a variety of ETFs that cover the sector. Because of the sector’s high profile, it is essential to know exactly what is under the hood of these ETFs.  The sector can be  subdivided into the following: broad-based, regional banks, capital markets, insurance and REITs.  John Gabriel of Morningstar breaks down the sector and provides an in-depth analysis of industries that constitute the financial sector.

The most widely held and common financial ETFs are broad-based financials, which include the SPDR Select Sector Financial (XLF) and the Vanguard Financials (VFH). Banks constitute nearly half of the asset base of XLF and 42% of VFH, insurance companies account for nearly 18% of XLF and 22.5% of VFH and capital markets soak up about 19% of both XLF and VFH.

In regard to the banking sector, some common ETFs investors look at are the SPDR KBW Bank (KBE) and the PowerShares Dynamic Banking (PJB). KRE is heavily exposed to banks operating in the Pacific region, nearly 25% of its assets, whereas PJB holds about 6% of its assets in this region.  Additionally, KRE is the only regional bank ETF which doesn’t hold stakes in large money center banks, whereas 10% of PJB’s assets are allocated to this specialty.

As for capital markets, investors can grab exposure to exchanges alongside brokers, money managers, and former investment banks through the SPDR KBW Capital Markets (KCE) and the iShares Dow Jones US Broker-Dealers (IAI). Both funds are nearly identical, except that KCE includes a sampling of traditional asset managers in its mix.

When it comes to insurance, investors can grab exposure through the PowerShares Dynamic Insurance (PIC), SPDR KBW Insurance (KIE) and the iShares Dow Jones U.S. Insurance (IAK). The major difference between these ETFs mainly lies in their exposure to life insurers.  PIC has 3% of its assets to the subindustry, whereas KIE and IAK have 22% and 23% allocated to life insurers, respectively.

As for real estate investment trusts (REITs), the most common ETFs include the iShares Dow Jones U.S. Real Estate (IYR) and the Vanguard REIT Index (VNQ). A big difference between these two ETFs is that IYR contains mortgage REITs and unconventional holdings such as timber REITs and real estate services firms while VNQ limits itself to primarily conventional REITs.

In addition to knowing what an ETF holds, we suggest one watch the trendlines and have a strategy as this sector continues its recovery, as well.

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