Who are Financial Majors

The most significant part of the financial sector is the loan market. Financial giants like JPMorgan Chase, Wells Fargo, Bank of America, and Citi group support consumer loans, small business lending, housing (mortgages), as well as big projects like commercial buildings or infrastructure that require substantial financial resources. Many of the mentioned banks are also Investment banks. They help companies to go public (IPO), facilitate mergers and acquisitions, stocks and bonds issues, and also act as financial advisors. In terms of size, right after the banking industry follows the insurance industry. It includes companies such as American International Group (AIG) in the USA. The function of insurance companies is to maintain stability in the economy by redistributing the financial risk among market participants. The way they do it is generally charging customers a premium for the obligation to cover the financial losses of the customers in case of predetermined undesirable events such as accidents, health damage, natural disasters, etc.

Tight relationships with the Economy

The income in this industry typically comes from an interest or a service fee. Basically: if the business is growing and consumers are spending – the financials are doing great. The sector particularly thrives in the low-interest rates environment as the volume of the loan applications increases, so the absolute amount of the profits that come from the interest payments.

The financial sector signals about the health of the economy as the economic activity is dependent on financial services. That makes financials are highly correlated with other sectors of the economy. 

Let’s look at the “ties” of Financial Select Sector SPDR Fund (NYSE: XLF) with the overall market below. For the last two decades, the correlation has been mostly above 0.5 (see the grey indicator under the XLF chart).

Financials ETFs chart

Advantages of investing in the Financial sector

Financials are everywhere

Banks are involved in the success of many other industries as any business cannot hive off the financial services. The growth of a country’s GDP is significantly contributed by Financials as well. Financials impact the lives of consumers and institutions. There is another good reason to consider particular financial companies to keep as part of your portfolio. Some of them, especially banks, became particularly crucial for the health of the overall economy.

Majors are too big to fail

Some financials grew that big, that their possible collapse would threaten the order of the whole financial system leading to irreversible consequences. Known as “Too big to fail”, these companies would most likely be bailed out by the government in case of the possible state of insolvency. During the 2008 financial crisis Bank of America, Citigroup, and others got bailed out by 700$ billion injections approved by the US Treasury Department; the insurance company American International Group (AIG) received the biggest portion of the injection. Picking the right financial giants as part of the investment portfolio can reduce the risk dramatically while the exposure to their earning potential offers meaningful rewards.

Here is the list of the banks considered by US Federal Reserve as “Too big to fail”:

  • Bank of America Corporation
  • The Bank of New York Mellon Corporation
  • Barclays PLC
  • Citigroup Inc.
  • Credit Suisse Group AG
  • Deutsche Bank AG
  • The Goldman Sachs Group, Inc.
  • JP Morgan Chase & Co.
  • Morgan Stanley
  • State Street Corporation
  • UBS AG
  • Wells Fargo & Company

Point to the new economic cycle

The financial sector may also be an early indicator of the economic cycle turn. It’s characterized by significantly diminished risk aversion of banks’ business practices. For instance, reduced bank capital requirements and drastically increasing private debt can give a clue about the coming economic contraction.

The Major Financial sector ETFs

Exchange-Traded Funds is a great tool to get exposure to the Financials avoiding the hustle of hand-picking individual stocks or managing baskets of them, paying fatty transaction fees to your broker by the way.

These are the top Financials ETFs by their assets under management:

  • Financial Select Sector SPDR Fund (NYSE: XLF)gets investors exposed to the broad range of the financial industries such as banks, insurance, real estate trusts, thrifts, mortgages, consumer finance, etc. This product holds the shares of the biggest players in the financial industry. They are often the subject of the scrutiny by the US government to ensure their practices are financially safe for the economy. As a result, the product is likely to be affected by government policies. 
  • Vanguard Financials ETF (NYSE: VFH)– from the first sight might appear resembling XLF. However, the assets structure of VFH is quite different. VFH puts more emphasis on small and mid-cap stocks, thus being less concentrated than XLF.
  • iShares US Financial Services ETF (NYSE: IYG) – focuses more on the financials’ sub-sector including the largest banks, real estate, and general finance firms. Being dominated by large caps, the holdings are quite concentrated. Getting exposed to this ETF would be more suitable to catch some short-term move opportunities.

Most of the ETFs’ holdings include the big names of the industry. Both Vanguard Financials ETF (VFH) and Financial Select Sector SPDR Fund (XLF) include JPMorgan Chase & Co, Warren Buffet’s fund Berkshire Hathaway Inc and Bank of America Corp. iShares US Financial Services ETF (IYG) holds JPMorgan Chase & Co as well, although being more exposed to payment systems holding Visa Inc and Mastercard Inc. Here are the major ETFs of the Financial sector and their annual dividend yields along with the expense ratios:

ETF Name Total Assets Annual yield Expense ratio
Financial Select Sector SPDR Fund $16,020.7 M 2.7% 0.13%
Vanguard Financials ETF $5,744.9 M 3.07% 0.10%
iShares U.S. Financial Services ETF $1,557.2 M 2.06% 0.42%

When and How to trade financial ETFs

After the steady period of the low-interest rates, as the volumes of interest payments to financial companies consistently grow, financials benefit even more when the regulator starts to raise the interest rates. Let’s see how these fundamentals can help the investor in the Financial ETFs. After the rates plateau (see the rounded areas), Federal Reserve raised the interest rate in July 2004 and December 2015 (see the green vertical lines) that was followed by the growth in XLF. An investor can buy Financials ETF at the time of the rate hike after the plateau, benefiting from the proceeding rally in the instrument.

When and How to trade financial ETFs

The Bottom Line

All financials play a vital role, maintaining stability in business activities. They primarily determine the health of the economy. Therefore the first signs of change in the economic cycle can be observed in the banking sector. Financials are an integral part of the well-diversified portfolio. The organizations of the systematic importance carry the status “too big to fail” which in case of the risk of insolvency would be likely bailed out by the government. Various kinds of Financials ETFs enable an investor to get exposure to the sector. As the sector is sensitive to the interest rates, we can exploit this correlation to make smart trading decisions.