RYF Diversification Can Ease Financial Services Investing Stress

Following a March marred by bank collapses and elevated duress in the global banking system, some market participants are rightfully pensive about embracing financial services equities and the related exchange traded funds. On the other hand, now could be an opportune time to, at the very least, keep an eye on the space while remembering the sector is comprised of much more than just money-center banks. The Invesco S&P 500 Equal Weight Financials ETF (RYF) could be the ideal avenue for investors looking to buy the dip in this sector while minimizing bank exposure.

While bank branches are commonplace throughout the U.S., investors should note that many RYF components qualify as wide moat firms, implying they have sturdy competitive advantages that can pay off for investors in volatile markets and over the long haul.

Once established with a bank or asset manager, for example, customers are unlikely to leave. Another edge is the network effect: The more people who use a credit card or index, the more valuable it becomes. Cost advantages come with size and scope. Then there are intangible assets, such as brand names that inspire customer confidence,” noted Morningstar analyst Katherine Lynch.

Add to that, RYF components American Express (AXP), Mastercard (MA) and Visa (V) — the latter two of which are new members of the financial services sector — have impressive credentials when it comes to network effects.

Mastercard and Visa “have developed two of the largest payment networks, insulating them from competition. These large networks also create cost advantages,” added Lynch.

The network effect also applies to financial data providers, including ratings and index providers. S&P Global (SPGI) is involved in both businesses while Moody’s (MCO) is a dominant debt grader and MSCI (MSCI) is tethered to the ETF boom be being one of the premier index providers, alongside S&P. All three are RYG holdings.

“Similar to credit card companies, financial data providers benefit from network effects. Those with established reputations, track records, and relationships also have intangible assets that make it difficult for newcomers to compete and create switching costs for customers,” concluded Lynch.

As for diversification benefits, RYF has those as well. None of its 74 holdings command a weight in excess of 1.60% and bank stocks represent just 19.25% of its weight as of April 19. That’s the third-largest industry exposure in the equal-weight ETF.

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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.