This universe is defined by the Industry Classification Benchmark (ICB), which is the classification system designed by Dow Jones and FTSE, which is now solely owned by FTSE. This distinction may seem trivial, but it’s germane, because ICB differs from the classification system used by KRE: the Global Industry Classification Standard (GICS).
Each classification system begins with 10 headline sectors (or in the case of ICB, industries) and, like a family tree, branches out to more specific industries (sectors) and subindustries (subsectors). Unlike GICS, ICB does not have a regional banking subgroup, or at least not one that is publicly available.
This means that IAT’s universe is determined simply by relative market cap: Any firm that accounts for more than 5 percent of ICB’s U.S. banking sector is ineligible. For example, U.S. Bancorp gets a near 20 percent weighting in IAT even though it’s hard to argue that U.S. Bancorp is a regional bank.
KRE, on the other hand, equal-weights the regional banking firms it holds. That means PNC, which gets an 11 percent weighting in IAT, accounts for just 1.7 percent of KRE’s 79 holdings. It also means KRE has a significantly smaller market-cap profile than IAT.
The weighted average market cap of KRE is just $4.6 billion versus $25.5 billion for IAT. To add more color, 56 percent of IAT is invested in large-cap banks (greater than $12 billion market cap), while 90 percent of KRE is in small- and midcap banks.
In addition, KRE uses a business-focused model to classify regional banks:
“Commercial banks whose businesses are derived primarily from conventional banking operations and have significant business activity in retail banking and small and medium corporate lending. Regional banks tend to operate in limited geographic regions. Excludes companies classified in the Diversified Banks and Thrifts & Mortgage Banks sub-industries. Also excludes investment banks classified in the Investment Banking & Brokerage Sub-Industry.”
This, combined with the drastically different profile of KRE’s portfolio, makes the two distinctly different takes on the regional banking market. I am in no position to say which approach is superior, but I do know that the 14 bp difference in round-trip costs between the two funds pales in comparison with the difference in exposure.
As a passive investing flag bearer, I tend to gravitate to cap-weighted funds, but in this case, the more rigorous classification process used by KRE aligns better with my sector investing sensibilities. As a soccer (football) fan, I’m comfortable calling this a draw.
At the time this article was written, the author held no position in the securities mentioned. Contact Paul Baiocchi at [email protected].