Betting on Brokerage ETFs

For better or worse, the largest investment banks and brokerage houses in the U.S. are household names. Think Goldman Sachs (NYSE:GS), Morgan Stanley (NYSE:MS) and friends. However, brand recognition and notoriety for these firms has not always translated to popularity and inflows for ETFs that focus on capital markets firms.

This year, new regulatory guidelines could lead to a higher cost of doing businesses for many Wall Street banks and with that in mind, S&P Capital IQ took a look at two ETFs comprised primarily of capital markets firms.

"In the year ahead, we see modest revenue gains in investment banking," said S&P Capital IQ in a research note. "We view several factors as key determinants of whether there will be improvement in underwriting and advisory fees. First, we think there is a positive correlation between equity market appreciation and IPO activity, boosting private companies' incentive to go public when valuations are higher. Second, CEO confidence levels remain near record lows, which is a pretty good barometer for potential M&A activity. And finally, we view high levels of cash on corporate balance sheets as additional support for M&A activity."

Should companies decide to put some excess cash to work through mergers and acquisitions, the iShares Dow Jones U.S. Broker-Dealers Index Fund (NYSE:IAI) is one ETF that could benefit. S&P Capital IQ rates that ETF Overweight. IAI, which has almost $49.1 million in assets under management, counts Goldman Sachs and Morgan Stanley among its top two holdings. Those stocks combine for almost 15 percent of the fund's weight.

IAI has gained 17.6 percent in the past year and recently broke through some stiff resistance at $24. With a P/E of 18.33 and a price-to-book ratio of 1.57, IAI is a bit more expensive than the iShares Dow Jones U.S. Financial Sector Index Fund (NYSE:IYF), though IAI's beta of 1.57 against the S&P 500 implies a higher degree of volatility compared to some other financial services ETFs.

S&P Capital IQ also has an Overweight rating on the SPDR S&P Capital Markets ETF (NYSE:KCE). Using more of an equal weight approach, KCE is home to 49 holdings, double that of IAI. However, KCE's composition has lead to vastly different returns over the past year.

For example, Goldman is KCE's largest holding as well, but at a weight of just 2.82 percent. Still, KCE has surged almost 28 percent in the past year. Other top-10 holdings in KCE include Lazard (NYSE:LAZ), Northern Trust (NASDAQ:NTRS) and Charles Schwab (NYSE:SCHW).

KCE has just $23.1 million in assets under management, but its expense ratio of 0.35 percent is below the 0.47 percent charged by IAI.

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