Now that Goldman Sachs (NYSE:GS) has been charged by the SEC it is probably as good a time as any to take stock of your ETF inventory and look for opportunities to reduce your exposure to Goldman while they struggle with their legal challenges.
As of the close of business on Friday, April 16, 2010 the State Street Financial Select SPDR (NYSEARCA:XLF) reported that 4.74% of its holdings were invested in Goldman Sachs. This translates to the possibility that holders of XLF may be faced with almost 4.74% of their investment may be in the underperformance category for the near future. Considering the YTD performance of XLF s 11.02% and the 1 Year Performance is 83.20 % (The highest in the SPDR family) tolerating underperformance may just be something that the longer term investor is willing to accept.
The sector breakdown for the S&P500 to financials is currently 16.4%. If you have chosen XLF with such a large portion of their underlying invested in GS you will be handicapped until the dust settles.
He are two suggestions in the ETF space that will help defer the impact of the expected underperformance of Goldman Sachs (GS) while more importantly addressing the future risk that the larger capitalization firms may face.
The Rydex Equal Weight Financial ETF (NYSEARCA:RYF). RYF currently has investments in 79 underlying financial services companies. YTD performance on RYF is 13.68% while the 1 year performance number is 103.16%. The strategy employed by RYF is designed to replicate the Standard and Poor’s Financial Equal Weight Index. The strategy will purposely underweight larger firms, this is in contrast to the standard cap weighted indices. For example RYF has an allocation to Goldman Sachs of 1.11%.
The First Trust Financials AlphaDex ETF (NYSEARCA:FXO) is another interesting equal weighted option. This particular ETF employs the AlphaDex stock selection methodology which uses fundamental growth and value factors to identify stocks which will deliver positive alpha over traditional passive indices. The higher the ranking the higher weight within the index. Thus resulting in a modified equal weighted index. The current allocation to GS is .84%. Interestingly enough the highest weighted stock in FXO is MBIA Inc. (NYSE:MBI) with a weighting of 1.64%. In the event that CDO’s and other mortgage backed securities MBIA insured are found to have been fraudulently structured the firm may be able to recover some of its losses.
While the reduction in exposure to the large firms like Goldman could be considered good defense, the offensive play in these particular ETF’s may be even stronger. With an equal or modified-equal weighting to mid to small capitalization companies, an investor could stand to reap the benefits of future consolidation in the sector. We have all heard of “Too Big to Fail”, the largest cap financial sector firms are simply “Too Big to Grow Organically”. As earnings pressure continues to mount the most cost effective way for them to grow their bottom line will be through acquisition. Ironically the same day that the SEC announced its probe into Goldman Sachs we saw good evidence of the need to acquire when Toronto Dominion (NYSE:TD) announced it was buying certain assets and liabilities of three troubled Florida banks worth $3.8 billion from the Federal Deposit Insurance Corp (FDIC). This pattern of acquisition is bound to continue.
Disclosure: Long FXO and TD