Financial services companies are struggling with mortgage settlement expenses and regulatory uncertainty. These uncertain factors are causing increased volatility in the sector making active financial services funds safer investments in the current market's environment.
Bank of America (BAC) provides an example of this. The company generated fourth quarter earnings of $732 million from its six business lines in 2012, according to its earnings release on January 17. Quarter-over-quarter, net income was $392 million higher. Fourth quarter net income was $1.3 billion lower than fourth quarter 2011. Annually, net income for the company in 2012 was $4.2 billion, $2.7 billion higher than 2011.
While the company's year-over-year earnings improvement helped the stock price it is still weighed down by industry mortgage settlements and regulatory uncertainty that could result in tax rate changes and additional Dodd-Frank like stipulations.
On a one-year basis the stock has gained 70.65 percent. However, on a three-year return basis the stock has lost 30.62 percent and on a five-year basis the stock has lost 68.64 percent.
Given the sector's risks, it also appears overvalued at its current price of $11.28. Based on Bodie, Kane and Marcus' intrinsic value formula (see note below) the stock has a one-year price target of $9.99. In the day following the company's earnings release, the stock price fell 4.24 percent converging toward its lower price target.
As financial services stocks continue to recover from 2008's lending crisis, actively managed funds in the sector appear to provide safer investment options.
The Schwab Financial Services Fund (SWFFX) is a leading mutual fund investment that provides investors with diversified exposure to financial services stocks at a low management fee.
The fund holds 57 stocks in the financial services sector. Its top-three holdings are Wells Fargo & Co., JPMorgan Chase & Co. and Bank of America. Additional performance return data comparisons for the fund are included in the table below.
For investors seeking exposure to the U.S. financial services sector the Schwab Financial Services Fund provides capital gains potential at a lower risk than individual stock investment.
Note: The intrinsic value formula discounts the projected one-year value by the risk-free rate on the one-year Treasury note plus a beta of 1.78 times the market's risk premium. The market risk premium assumes stock market appreciation in 2013 to be similar to 2012 and is based on Dow Jones Industrial Average index return.