Market Overview

Brokerage ETF Battle: Plenty of Winners

Brokerage ETF Battle: Plenty of Winners

Financial services ETFs have been stellar performers this year. An average year-to-date return of 19 percent for the Financial Select Sector SPDR (NYSE: XLF) and the Vanguard Financials ETF (NYSE: VFH) indicates as much.

Add to that, it is not a stretch to say that this sector is one of the most covered by the financial press. Whether it is good news or bad news, investors are treated to ample coverage on companies such as Goldman Sachs (NYSE: GS) and Morgan Stanley (NYSE: MS). For those reasons, it is somewhat surprising that more attention is not paid to the sub-sector ETFs that are explicit plays on investment banks, brokerage houses and capital markets firms.

There at least three such ETFs and that trio, which will be highlighted, barely has a combined $200 million in assets under management. Only one of those funds, the iShares U.S. Broker-Dealers ETF (NYSE: IAI), has over $100 million in AUM, and IAI only recently accomplished that feat.

In other words, these are the type of the ETFs that critics love to hate. Let the haters hate because ignoring the following ETFs based on size, or lack thereof, has proven quite costly.

iShares U.S. Broker-Dealers ETF
Starting with the group's largest member, let's have a look at the iShares U.S. Broker-Dealers ETF. As an aside, it appears as though money is continuing to flow into IAI as the ETF is up 1.2 percent today on volume that is more than double its daily average, a pretty nifty feat for a slow trading day such as the day after the Fourth of July.

The 19 percent average year-to-date return offered by XLF and VFH is nice and should not be complained about. Well, if one does not know about IAI and the nearly 29 percent the ETF has returned this year then 19 percent is nice.

IAI is home to 22 stocks with Goldman, Charles Schwab (NYSE: SCHW) and Morgan Stanley combining for over 20 percent of the fund's weight. In other words, this is not an ETF that suffers from liquidity problems and we know this because in the second quarter, IAI never traded at a premium or discount to its net asset value of more than 0.5 percent, according to iShares data.

Here's a tip: If you use an adviser or hedge fund manager that told you to stay away from IAI in January because the ETF was too small, fire that person right away.

SPDR S&P Capital Markets ETF (NYSE: KCE)
If IAI is too small for the critics, than what will they say about the SPDR S&P Capital Markets ETF? KCE has just $68 million in AUM. There are differences between IAI and KCE, including the fact that the latter holds 51 stocks. KCE is also sort of an equal-weight play as none of its holdings garner more than a 3.3 percent weight.

The overall breakdown with KCE 63 percent to asset managers and custodial banks and 37 percent to investment banks. KCE is up almost 15 percent year-to-date and features a tidy 3.4 percent dividend yield, according to State Street data.

PowerShares KBW Capital Markets Portfolio (NYSE: KBWC)
If IAI is small and KCE is smaller, than the so-called experts would have certainly told investors to stay away from the diminutive PowerShares KBW Capital Markets Portfolio because KBWC has just $8.1 million in AUM.

Surely, with just $8.1 million in AUM KBWC would qualify as illiquid, providing the aforementioned "experts" with plenty of valid reasons to keep investors away from the fund, right? Wrong. While data for the second quarter is not yet available, the previous four quarters worth of data show that on just one occasion did the mid-point of KBWC's bid/ask spread trade at a sort of noticeable discount or premium to the ETFs underlying NAV.

State Street (NYSE: STT), Morgan Stanley and Goldman combine for 27 percent of KBWC's weight. KBWC is proof positive that ignoring some small ETFs due to perceived liquidity risks is a bad idea. The data indicate this ETF is sufficiently liquid. The returns show an ETF that is up more than 26 percent this year.

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