Looking for Enthusiasm With Financial Services ETFs

That much has been hard to find this year with exchange traded funds tracking the financial services sector, the second-largest sector weight in the S&P 500.

Down 1.2% year-to-date, the Financial Select Sector SPDR (NYSEArca: XLF), the largest financial services ETF, is one of three of the nine sector SPDR ETFs that have traded lower this year. However, the financial services sector is seen as fundamentally sound, recent earnings and dividend increases confirm as much, and under-owned by professional investors. And there is the notion that lagging sectors do have the potential to shed their disappointing ways to become leaders. [Time to Look at Bank ETFs]

A healthy U.S. economy and an interest rate hike from the Federal Reserve, two variables that come with no guarantees, are seen as positive catalysts for XLF and rival financial services ETFs.

“Financial companies are highly sensitive to small moves in the U.S. economy. The reason is that even seemingly small changes in unemployment and consumer confidence can have an outsize impact on loan repayment rates and the willingness to borrow. Other aspects of the economy, including interest-rate movements, the health of the housing market, and even the shape of the yield curve, can provide headwinds or tailwinds for financials firms,” said Morningstar analyst Robert Goldsborough in a recent note.

A selling point for the $17.1 billion XLF is its diversity across multiple financial services sub-sectors. Although, Wells Fargo (NYSE: WFC), J.P. Morgan Chase (NYSE: JPM) and Bank of America (NYSE: BAC) combine for over 22% of the ETF’s weight, XLF is not a dedicated money-center bank fund. [Investors are Overlooking Financial ETFs]

After its 36.1% weight to banks, XLF has a 16.5% allocation to rate-sensitive insurance providers, a 15.2% weight to real estate investment trusts (REITs) and a 14.1% to capital markets firms, such as Goldman Sachs (NYSE: GS) and Morgan Stanley (NYSE: MS).