Sector exchange traded funds have become increasingly popular with advisors and investors. While broad market funds such as the SPDR S&P 500 ETF (SPY) give investors the benefit of diversity, sector funds allow users to overweight a specific group in an effort to identify potential outperformance.
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Sector ETFs also allow investors to hone in on valuation opportunities, rotating out of richly valued groups and into sectors that look undervalued. That was one reason why the Financial Select SPDR (XLF) and other financial services ETFs saw a flurry of activity in late 2017.
XLF, the largest ETF dedicated to the financial services sector, rose 22 percent last year and is off to a fine start in 2018. The fund is already up 7.3 percent since the beginning of the year, easily making it one of the best-performing sector ETFs since the start of the year.
For financials, Capital IQ consensus forecasts call for 28-percent earnings growth in 2018, well ahead of the broader S&P 500's 15-percent growth, CFRA Research Director of ETF & Mutual Fund Research Todd Rosenbluth said in a Thursday note. Earnings for the sector were projected to increase 8.7 percent in 2017 as of Jan. 19 as fourth-quarter earnings season was getting started.
Rosenbluth adds that there are 25 financial services stocks in the S&P 500 that CFRA has Buy or Strong Buy ratings on, including XLF holdings JPMorgan Chase & Co. (JPM) and Bank of America Corp. (BAC). Those two stocks are XLF's second- and third-largest holdings, respectively, and combine for almost 19 percent of the ETF's weight.
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XLF devotes 45 percent of its lineup to bank stocks while capital markets firms and insurance providers combine for over 38 percent.
"Chris Dhanraj, head of iShares Investment Strategy, also highlighted to CFRA that he finds the financials sector appealing as he thinks banks will likely benefit from net interest margin expansion and deregulation, while insurance companies would be aided from higher interest rates, said Rosenbluth.
IAK holds 63 stocks, but the ETF is cap-weighted, so larger insurance providers dominate the fund. IAK's top 10 holdings combine for over 57 percent of the ETF's weight. IYG and IAK are up an average of 6 percent this year.
CFRA has Overweight ratings on IAK, IYG and XLF.
Todd Shriber owns shares of XLF.
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