The recent shocker from the Federal Reserve has thrown markets off their bullish course. Now, investors are beginning to prepare for a life with higher rates, less stimulus, and possible bond losses.
While this situation is somewhat unwelcomed news to a number of investors, there are undoubtedly a few sectors that are cheering on the Fed’s fresh policy line. In particular, the banking sector could be a big beneficiary from this new trend (see 4 ETFs on the Move After Bernanke Press Conference).
The banking sector could be a winner from a steepened yield curve thanks to their business model which seeks to take in deposits and pay out short term rates, and the lend capital back at longer term rates. Since the Fed is widely expected to hold the short-end of the curve down near zero percent while the longer end rises, the spread could surge between these two key figures.
And when this spread increases, generally so do profits for banks. This could make now a great time to invest in banking securities, especially considering that other segments of the economy are not poised to do as well in this rising long term rate type of environment.
Will Any Bank Do?
However, investors should note that not just any banking institution will do in this new situation. Instead, you should probably focus on regional banks as opposed to their massive global cousins (see Time to Bank on Regional Bank ETFs?).
This is because regional banks are generally more focused on basic banking activities—like taking deposits and lending—while bigger banking conglomerates have more diversified operations with trading portfolios and global exposure. Due to this, a focus on smaller banks seems ideal, as it avoids the troubles that could be brewing in some segments of bigger banks, and zeroes in on the steepening yield curve story.
How to Play
While investors can invest in a number of single stocks to play the trend, an ETF approach could also be a good idea. In this way, investors can spread risk around a number of securities, and truly tap into the trend of the regional banking market.
Two such ETFs that offer exposure to this trend are the PowerShares KBW Regional Banking Portfolio (KBWR - ETF report) and the SPDR S&P Regional Banking ETF (KRE - ETF report). These products both provide investors with diversified exposure to a good sized basket of regional banks, focusing on companies classified as small caps.
While the two might appear the same at first glance- similar focus and expense ratios-- there are actually some key differences to be aware of in this space. First, KBWR is a cap weighted fund, while KRE has an equal weight focus (see Are Equal Weight ETFs Worth the Cost?).
Additionally, KRE is far more popular in terms of assets and volume, crushing its counterpart in both respects. However, KBWR could be a better play for investors seeking a concentrated look at the smaller companies in the space, as it puts less than 20% of its assets in companies mid cap sized or bigger, while KRE allocates more than one-third of its portfolio to these sized firms.
There are a few other key items that you should know about this new type of rising rate environment and how it might impact banking ETFs though. You can learn about them in our short video on the subject below:
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