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ETF Specialist

An ETF for Low-Cost Exposure to Large-Cap Financials

With an interest-rate hike at the forefront, here's a closer look at an inexpensive financial-services exchange-traded fund.

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Speculation surrounding the timing of interest-rate hikes has been in the news in recent weeks. With quantitative easing in the rearview mirror and recent reports of economic weakness, there is a greater likelihood of the Federal Reserve raising interest rates sooner rather than later. With that in mind, one might consider taking a bullish view toward financial firms, given that large banks dominate the financials sector, and ongoing low interest rates have meant continued pressure on banks' net interest margins. While higher rates may well serve as a tailwind for financials firms over the longer term, any immediate benefit from an interest-rate hike for financial-services firms would be muted at best, as higher rates will not translate one-for-one into higher earnings for banks. Bank earnings and valuations are driven more by net interest margins, which are more stable over time, than by rates themselves. Morningstar's equity analysts don't expect interest-spread revenue at U.S. banks to grow anytime soon. Instead, they believe low loan yields will keep interest-spread revenue at the same level or even will decline.

Regardless of interest-rate uncertainty, the U.S. financial-services sector is one of the more attractively valued U.S. equity sectors at this time, trading at 95% of Morningstar's equity analysts' estimate of fair value. And for investors seeking broad exposure to the U.S. financial-services sector,  Financial Select Sector SPDR ETF (XLF) is a suitable option. Unlike many other U.S. equity sectors, the financial-services sector has not returned to its precrisis highs. The reasons for this have been well-documented, including greater regulation, continued ultralow interest rates, asset write-downs, and higher capital requirements.

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Robert Goldsborough does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.