Financial Sector Funds And ETFs To Avoid


Investors should not buy any financials ETFs or mutual funds because none get an attractive-or-better rating in my Sector Rankings for ETFs and Mutual Funds report.

I assess ETFs and mutual funds based on the quality of their holdings, first and foremost, because holdings determine the performance of the fund, not just the costs or the past performance of the fund. My predictive ratings are based on (1) the aggregated stocks ratings of the holdings and (2) the all-in expenses of each ETF and mutual fund. Costs matter because they can handicap performance of a fund, but the quality of holdings is paramount because no matter how cheap the fund, the performance will be bad if the holdings are bad.

Best & Worst ETFs

Best & Worst Mutual Funds

iShares FTSE NAREIT Mortgage REITs Index Fund (REM) is my top-rated financials ETF and Davis Financial Fund (DVFYX) is my top-rated financials mutual fund. Both earn my neutral rating.

iShares FTSE NAREIT Industrial/Office Capped Index Fund (FNIO) is my worst-rated financials ETF and Forward Funds: Forward Real Estate Fund (KREAX) is my worst-rated financials mutual fund. Both earn my very dangerous rating.

Figure 3 shows that 75 out of the 565 stocks (over 2% of the total net assets) held by financials ETFs and mutual funds get an attractive-or-better rating. However, no financials ETFs and no financials mutual get an attractive-or-better rating.

The takeaways are: mutual fund managers allocate too much capital to low-quality stocks and financials ETFs hold poor quality stocks. Investors can get higher returns for lower costs by investing in the right individual stocks in this sector.

Figure 3: Financials Sector Landscape For ETFs, Mutual Funds & Stocks

Investors need to tread carefully when considering financials ETFs and mutual funds, as no ETFs or mutual funds in the financials sector allocate enough value to attractive-or-better-rated stocks to earn an attractive rating. Investors should focus on individual stocks instead.

Citigroup  (C) is one of my least favorite stocks held by financials ETFs and mutual funds and earns my very dangerous rating. Citigroup is an example of how GAAP net income can be misleading. Citigroup’s GAAP net income rebounded after the financial crisis and managed a slight growth of 3.3% last year. The company’s true after-tax cash flow (NOPAT), on the other hand, declined by a whopping 71% last year. Citigroup’s share price of ~$42 implies that the company will rebound and grow NOPAT by 29% compounded annually for the next eight years. Such a turnaround would be awfully impressive, but investors would not be wise to bet that the company will meet or exceed those expectations, which is exactly what they are doing by owning the stock.

The Progressive Corp (PGR) is one of my favorite stocks held by financials ETFs and mutual funds and earns my very attractive rating. PGR boasts a top quintile ROIC of 19% and rising economic earningsalong with a 9% free cash flow yield. At ~$22.5/share, PGR trades at a price to economic book value ratioof 1.0. This valuation implies that PGR will never grow NOPAT from its current level. Expecting zero growth from a company that has grown NOPAT at 7% compounded annually since 1998 seems overly pessimistic.

Sam McBride contributed to this report.  David Trainer and Sam McBride receive no compensation to write about any specific stock, sector or theme.

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