Inside Bank and Financial ETFs: How Do They Compare?

Two other analysts whose blogs I monitor wrote in their midyear reports that they were bullish on bank and financial ETFs. My analysis using ValuEngine data below differs significantly.

One analyst singled out KRE and the other’s favorite was FTXO.  They cited that the P/B and P/E ratios were considerably lower than the market averages.  Moreover, since the economic expansion is expected to continue and banks must play an essential role in such an expansion, they argued that the recent surge in prices of these ETFs still had plenty of room to run further.  I was intrigued enough to feature these ETFs in this week’s blog.  I also included the two largest ETFs in the sector as ranked by AUM: XLF and VLH.  Here is my dive into the comparative numbers for the following ETFs:

• XLF, Financial Select Sector SPDR Fund
• VFH, Vanguard Financials ETF
• KRE, SPDR S&P Regional Banking ETF
• FTXO, First Trust Nasdaq Bank ETF

The following table provides much of the pertinent information available as of August 1, 2021.  IVV, the iShares S&P 500 ETF, is used for benchmarking.

Salient observations we can make:

1. The ValuEngine models very strongly disagree with the two analysts.  All four ETFs get ValuEngine’s lowest rank of 1. 
2. While the 12-month outlook for the S&P 500 as represented by IVV is negative at -4%, all four Financial Sector ETFs are expected to fall more than twice as much. 
3. Given that all four ETFs significantly underperformed in the past 3-, 5- and 10-year periods, the 1-year superior return for all four just looks like an expected mathematical consequence of having started from a lower base when the mammoth rising tide lifted all boats from April 2020 into this year. 
4. The earnings forecasts for these ETFs while respectable enough do not justify additional deployment of assets away from broad market index ETFs or core mutual funds into any of these four financial sector ETFs. 
5. Although it is true that the Sector ETFs have higher dividend yields, substantially lower P/E ratios and higher P/B ratios, that is expected to be the case in most environments.  Banks are highly regulated with capital requirements that necessitate high book values.  There are also implicit risks surrounding the relative opaqueness of bank operations that have resulted in past disasters.  As a result, investors tend to require higher dividend yields and higher earnings/price ratios than they do from consumer-oriented sectors. 

Although our metrics do not support new investment in banks and financial services stocks over other segments of the market, some of our readers may want to despite our concerns.  So let us take a deeper dive just comparing the four ETFs excluding IVV.

1. One major difference is the overall target. XLF and VFH attempt to capture the entire financial sector including other types of financial services firms.  KRE and FTXO exclusively hold banks.
2. XLF and VFH are weighted by market cap.  KRE is equally weighted.  The components of FTXO are algorithmically weighted to maximize exposure to value, earnings growth and low volatility factors.  
3. With its 400+ holdings, VFH is easily the most well diversified of the four ETFs and has delivered generally superior historical returns with considerably lower volatility for the lowest expense ratio, just 10 basis points.  
4. Of the two financial sector ETFs, both market-cap weighted, there seems little reason to select XLF over VFH.  It has a slightly higher fee and far more concentration risk.  In fact, XLF gives considerably higher weighting to the same top ten holdings than VFH simply because it holds so many fewer stocks, all concentrated in exceptionally large market cap stocks.  
5. Comparing the two banks-only ETFs, KRE has the much lower expense ratio.  In terms of value characteristics, KRE is the best of the four ETFs with the highest yield, lowest P/E ration and lowest price/book ratio. KRE also contained the highest percentage of stocks considered undervalued by ValuEngine’s models as well as the top 12-month momentum as of July 11, 2021.  KRE is much more diversified than FXTO.  Its highest weighting, Silvergate Capital, comprised 1.9% and the other common holding in its top 10, PNC Financial constituted 1.7% of its portfolio.  In contrast, PNC comprised 8.2% of FTXO and Silvergate had a weight of 4%. The highest weighting in VFH was JP Morgan Chase.  Empirically, the choice is clear between KRE and FTXO in the five years that FXTO has been trading.  An investor looking to add extra regional bank exposure as a satellite equity position would derive more diversification and more potential for extraordinary returns with less expected price volatility from KRE.  

In conclusion, ValuEngine’s models indicate that most investors are probably better off deriving their financial services exposures through large benchmark ETFs than adding a financial services ETF to the mix.  That said, different investors interpret market opportunities differently.

Those who wish to shift some of the core to the financial services sector despite ValuEngine’s timing advice would be better off implementing this strategy with VFH than with XLF.  Investors whose insights tell them that regional banks are worthy of an investment as a new satellite position should probably focus on KRE and eliminate FTXO from consideration.