Financial ETFs Could Gain Momentum as Rates Rise Ahead | ETF Trends

Financial sector-related exchange traded funds could outperform this year as their bread-and-butter business could support higher growth with the Federal Reserve prepping multiple interest rate hikes.

As the Fed moves to raise rates for the first time in three years, banks’ net interest income, or the difference between deposits and lending, could begin to rise, especially as loan growth increases in an expanding economic environment.

The Fed has signaled that it will likely raise interest rates in mid-March, and the Federal funds futures market shows that options traders are pricing in at least three more rate hikes later in the year, Reuters reports.

“Banks that, for the last ten years, were not able to enjoy a steady yield curve are going to get it,” Ken Leon, research director at CFRA Research, told Reuters. “It’s likely to provide significant growth in net income interest revenues in 2022.”

Net interest income during the fourth quarter made up for 60% of revenue for the median bank among the biggest two dozen in the U.S., according to Barclays analyst Jason Goldberg. This net income as a portion of total revenue was the lowest in six years, and it was down compared to 66% three years ago.

Looking ahead, banks are already projecting improved revenue from net interest income. For instance, JPMorgan Chase & Co told analysts that net interest income from its businesses beyond securities markets could hit $50 billion in 2022 from $44.5 billion last year, a 12% rise. Wells Fargo & Co estimated that net interest income could increase by 8%.

“Some banks’ balance sheets are just more rate sensitive,” Goldberg said, projecting that the increases in net interest income will continue into 2023.

As investors look back into bank stocks, some may turn to broad financial sector-related ETFs to capture the rebound, including the Financial Select Sector SPDR (NYSEArca: XLF), the Fidelity MSCI Financials Index ETF (NYSEArca: FNCL), the iShares U.S. Financials ETF (NYSEArca: IYF), and the Vanguard Financials ETF (NYSEArca: VFH). The broad financial sector ETFs include hefty tilts toward big banks, but these broad sector plays also include other non-pure bank plays in the financial sector covering capital markets, insurance companies, diversified financial services, and consumer finance, among others.

On the other hand, investors can also turn to more bank-focused ETFs like the iShares U.S. Regional Banks ETF (NYSEArca: IAT), the SPDR S&P Regional Banking ETF (NYSEArca: KRE), the Invesco KBW Regional Bank Portfolio (NYSEArca: KBWR), and the SPDR S&P Bank ETF (NYSEArca: KBE). Potential investors should also note that State Street Global Advisors’ bank-related ETFs follow a more equal-weighted indexing methodology, so their holdings lean toward mid- or smaller-sized companies.

For targeted exposure to the small-sized banking segment, investors can look to options like the First Trust NASDAQ ABA Community Bank Index Fund (NasdaqGM: QABA) and the Invesco S&P SmallCap Financials Portfolio (NYSEArca: PSCF).

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