Best And Worst Financials Sector ETFs, Mutual Funds, And Key Holdings

|
 |  Includes: ALL, BDN, KBWC, KBWI, KBWP, KIE, ROOF, TNA
by: David Trainer

Summary

Lists of the Best and Worst ETFs and mutual funds in the Financials sector.

Distribution of all Financials sector ETFs and mutual funds across our Predictive Rating Scale.

Ratings are based on rigorous analysis of the profitability and valuation of each fund's holdings.

Our rating system is forward-looking and does not rely on past performance.

The Financials sector ranks ninth out of the ten sectors as detailed in my Sector Rankings for ETFs and Mutual Funds report. It gets my Dangerous rating, which is based on aggregation of ratings of 45 ETFs and 237 mutual funds in the Financials sector as of April 4, 2014. Prior reports on the best and worst ETFs and mutual funds in every sector are here.

Figures 1 and 2 rank the five best and worst ETFs and mutual funds in the sector that meet our liquidity standards. Not all Financials sector ETFs and mutual funds are created the same. The number of holdings varies widely (from 21 to 549), which creates drastically different investment implications and ratings. The best ETFs and mutual funds allocate more value to Attractive-or-better-rated stocks than the worst ETFs and mutual funds, which allocate too much value to Neutral-or-worse-rated stocks.

To identify the best and avoid the worst ETFs and mutual funds within the Financials sector, investors need a predictive rating based on (1) stocks ratings of the holdings and (2) the all-in expenses of each ETF and mutual fund. Investors need not rely on backward-looking ratings. My fund rating methodology is detailed here.

Investors should not buy any Financials ETFs or mutual funds because none get an Attractive-or-better rating. If you must have exposure to this sector, you should buy a basket of Attractive-or-better rated stocks and avoid paying undeserved fund fees. Active management has a long history of not paying off.


Figure 1: ETFs with the Best & Worst Ratings - Top 5

* Best ETFs exclude ETFs with TNAs less than $100 million for inadequate liquidity.

Sources: New Constructs, LLC and company filings

PowerShares KBW Property & Casualty Insurance Portfolio (NYSEARCA:KBWP), PowerShares KBW Insurance Portfolio (NYSEARCA:KBWI) and PowerShares KBW Capital Markets Portfolio (NYSEARCA:KBWC) are excluded from Figure 1 because their total net assets ((NYSEARCA:TNA)) are below $100 million and do not meet our liquidity standards. KBWP is the only ETF we cover to earn a Very Attractive rating, but its low level of liquidity makes it a risky bet for investors.

Figure 2: Mutual Funds with the Best & Worst Ratings - Top 5

* Best mutual funds exclude funds with TNAs less than $100 million for inadequate liquidity.

Sources: New Constructs, LLC and company filings

State Street SPDR S&P Insurance ETF (NYSEARCA:KIE) is my top-rated Financials ETF and Davis Series, Inc: Davis Financial Fund (MUTF:DVFYX) is my top-rated Financials mutual fund. Both earn my Neutral rating.

IQ US Real Estate Small Cap ETF (NYSEARCA:ROOF) is my worst-rated Financials ETF Rydex Series Funds: Real Estate Fund (MUTF:RYREX) is my worst-rated Financials mutual fund. Both earn my Very Dangerous rating.

Figure 3 shows that 87 out of the 587 stocks (over 10% of the market value) in Financials ETFs and mutual funds get an Attractive-or-better rating. However, none of the Financials ETFs and mutual funds I cover that have a sufficient amount of assets earn an Attractive rating.

The takeaways are: mutual fund managers allocate too much capital to low-quality stocks and Financials ETFs hold poor quality stocks.

Figure 3: Financials Sector Landscape For ETFs, Mutual Funds & Stocks

Sources: New Constructs, LLC and company filings

As detailed in "Cheap Funds Dupe Investors", the fund industry offers many cheap funds but very few funds with high-quality stocks, or with what I call good portfolio management.

Investors need to tread carefully when considering Financials ETFs and mutual funds, as no ETFs or mutual funds in the sector allocate enough value to Attractive-or-better stocks to earn an Attractive-or-better rating, except for the tiny KBWP. 69% of ETFs and 97% of mutual funds in the sector earn a Dangerous-or-worse rating.

Allstate (NYSE:ALL) is one of my favorite stocks held by Financials ETFs and mutual funds and earns my Very Attractive rating. It's also one of my Most Attractive stocks for April. ALL has bounced back well from the financial crisis and currently earns a return on invested capital (NASDAQ:ROIC) of 14%, above the industry average of 10%. ALL's 2013 reported income was adversely affected by the $700 loss it took on the sale of Lincoln Benefit Life Company. GAAP net income showed a slight decline, but true after-tax profits (NOPAT) actually increased by 18%.

Despite its strong recovery, the market still seems wary of ALL. At its current valuation of just ~$57/share, ALL has a price to economic book value ratio of 0.7, which a implies a permanent 30% decline in NOPAT. It's shocking to see such a large discount on a business as profitable as ALL with the amount of growth it's had recently. Low market expectations make ALL a great stock.

Brandywine Realty Trust (NYSE:BDN) is one of my least favorite stocks held by Financials ETFs and mutual funds and earns my Very Dangerous rating. The company's profits have been essentially stagnant over the past decade and its NOPAT declined by 4% in 2013. BDN's ROIC is low at 4% but actually right at the average for Office REITs. However, its valuation is significantly out of touch with reality. To justify its current stock price of ~$14/share, BDN would need to grow NOPAT by 6% compounded annually for 21 years. Again, this is a company with zero profit growth for the past decade. This disconnect between BDN's fundamentals and its valuation makes it one of the worst stocks in the sector.

587 stocks of the 3000+ I cover are classified as Financials stocks.

Figures 4 and 5 show the rating landscape of all Financials ETFs and mutual funds.

My Sector Rankings for ETFs and Mutual Funds report ranks all sectors and highlights those that offer the best investments.

Figure 4: Separating the Best ETFs From the Worst ETFs

Sources: New Constructs, LLC and company filings

Figure 5: Separating the Best Mutual Funds From the Worst Mutual Funds

Sources: New Constructs, LLC and company filings

Sam McBride contributed to this report.

Disclosure: David Trainer is long ALL. David Trainer and Sam McBride receive no compensation to write about any specific stock, sector or theme.

Disclosure: I am long ALL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.