Bank ETFs to Watch at a Historic Moment for the Sector

The latest turmoil doesn’t mean investors should shy away from financial institutions.

The banking industry dominated the headlines over the past month, and the biggest bank industry disturbance in 15 years isn’t likely to dissipate overnight.  

At a moment when risk is high but contrarian investors may have an excellent long-term setup, where should exchange-traded fund investors focus their attention as the second quarter begins? 

While equity analysts and investors are sorting through the array of individual circumstances at the more than 4,800 U.S. insured commercial banks, ETF investors are thinking in different terms. 

Since ETFs offer innate diversification, a crisis like this one is less about picking winners, and more about gauging reward opportunities while practicing risk management.  

The banking industry, and even the banking system, is causing stress for investors right now. The government is stepping in, and that is in part due to lack of supervision, as opposed to lack of regulation. That could be a formula for considerable volatility in the months ahead, as we see how far and wide the issues go, and how the stock market will react.  

When considering ETFs in the banking space, the impulse answer for some might be the Financial Select Sector SPDR ETF (XLF), the $30 billion behemoth that tracks the financial stock segment of the S&P 500 index.  

However, only 25% of XLF is in bank stocks, so unless the goal is to surround a big bank portfolio with insurance, capital markets and nonbank financial services companies, we have to get more granular.

The next step is to look at bank-focused ETFs. Three popular options include the Invesco KBW Bank ETF (KBWB), a top-heavy fund that owns 24 of the largest banks, or the SPDR S&P Bank ETF (KBE) and the SPDR S&P Regional Banking ETF (KRE), which spread their risk more than KBWB and have a modest degree of holdings overlap. 

These are all viable places to hunt for bank exposure. But for those who want to get more granular and identify less obvious spots to fish for bank exposure, there’s the First Trust Nasdaq ABA Community Bank ETF (QABA), an off-the-radar fund with only about $100 million in assets under management, and which zeros in on the most controversial segment the banking industry: community banks.  

Ironically, QABA was launched in mid-2009, in the wake of the last major financial crisis. It is down 18% during March (through 3/29 close), but with over 150 holdings, and only 25% in the top 10, it has the feel of a venture capital-like ETF, given the existential period the community bank business is currently enduring. 

Finally, for investors who look at the recent declines in the price of bank stocks, and consider it just the first shoe to drop, there’s the ProShares Short Financials ETF (SEF), which aims to perform exactly the opposite of XLF.  

Importantly, there is no leverage used here. The manager deploys a portfolio of 15 swap contracts with, ironically, major banks across the globe, to pursue that -1X objective. During the past three weeks, SEF’s assets have increased by 50%, but still only amount to about $40 million. 

So, investors have choices along several size and structure tiers in the banking ETF space. This reminds us that one of the most attractive long-term and tactical aspects of ETF investing is the ability to slice the equity market into a large array of pieces, so the investor can target the allocation and exposure they wish, while removing a significant amount of single-stock risk.