Financials: Next Domino To Fall

February 22, 2016

This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today's article features Clayton Fresk, CFA, portfolio management analyst at Georgia-based Stadion Money Management.

It has been a rather eventful past few months in the market. After a tumultuous third quarter and an optimistic fourth quarter of 2015, performance so far in 2016 has been brutal.

As of the close on Feb. 11, the S&P 500 was down some 10% for the year. Additionally, interest rates have plummeted, with the 10-year Treasury yield falling more than 60 basis points in 2016 alone. This combination of risk-off trading and a lower-rate environment has proved a strong head wind to the financial sector.

Financials is now the third GICS sector to enter a bear market (following energy and materials). There are different ETF offerings in the financial space, so let’s break down some industry exposure, and offer some alternatives.

Each financial ETF has a slightly different index and/or methodology. Here is a table with performance from 7/22/15 forward:

Ticker Fund AUM ($M) Performance: 7/22/15 - 2/11/16
XLF Financial Select Sector SPDR Fund 14,893.65 -22.26%
VFH Vanguard Financials ETF 3,016.21 -21.00%
IYF iShares US Financials ETF 1,102.09 -20.45%
FXO First Trust Financial AlphaDEX Fund 773.05 -18.97%
FNCL Fidelity MSCI Financials Index ETF 200.25 -20.91%
PSCF PowerShares S&P SmallCap Financials Portfolio 153.27 -17.52%
RYF Guggenheim S&P 500 Equal Weight Financials ETF 134.69 -20.27%
RWW Oppenheimer Financials Sector Revenue ETF 20.34 -23.79%

As you can see, performance across the funds has been weak, with all but FXO and PSCF seeing a greater than 20% drawdown over the period. It’s also interesting to note that smaller-cap names have delivered outperformance compared with their larger-cap counterparts. This is evidenced in the relative performance of PSCF, which focuses on the small-cap exposure, and of FXO, which has a greater allocation to the midcap financial names relative to the broader universe.

Industry Exposure

Within the financial space, we have also seen some divergence in the underlying industry exposure. Using XLF as an example, here is a breakdown of the underlying industry group exposure and corresponding performance over the same period:

As you can see, there is a decent amount of dispersion in the underlying returns. Those industries that face head winds from a lower rate environment—such as banks and capital markets—have fared much worse over the period. Conversely, industries that have a higher negative correlation to rate—namely, REITs—have stronger relative performance.

This industry exposure is another differential between those ETFs. Highlighting the same two ETFs as previously—FXO and PSCF—here is a weighting and performance comparison versus the XLF breakdown:

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