SPDR S&P Bank ETF (KBE) provides exposure to the banking sector. This narrowly focused exchange-traded fund tracks a benchmark index that excludes nonbank financial institutions such as REITs, insurance companies, and pure-play investment banks. The fund's focus means that it tends to be slightly more volatile than broader financials-sector funds, like Financial Select Sector SPDR ETF (XLF). (In comparison, XLF allocates 37% of its assets to banks.) Although most traditional deposit banks hedge a portion of their interest-rate risk, they are especially sensitive to changes in the shape of the yield curve. A flatter yield curve reduces the spread between the rate at which banks can borrow and lend because they fund most long-term loans through short-term deposits. A steepening yield curve tends to have the opposite effect. Consequently, KBE is an appropriate tactical satellite holding for investors who have a high risk tolerance and want to bet on a steepening yield curve and further improvements in the banking sector.
Unlike many other United States equity sectors, the financial-services sector still has not come back to its pre-financial-crisis highs. The reasons for this have been well-documented, including greater regulation, continued ultralow interest rates, asset write-downs, and higher capital requirements. As a result, investors in KBE are faced with considerable risks to the U.S. economy, given that small changes in unemployment and consumer confidence can have a significant impact on loan repayment rates and willingness to borrow. The strength of the housing market can also have a large impact on borrowing and default rates. Adding to these risks, commercial banks and thrifts face an unfavorable regulatory environment, rising capital requirements, and low interest rates, which may limit their profitability and increase competition.
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Robert Goldsborough does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.