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After an extremely rough phase in the financial crisis, the financial sector has come back strong and has been on a bull run since late 2012. In fact, the recent rally in the equity market was mostly thanks to the performance of the financial stocks.

Banks have bounced back following a series of hedging losses and scandals, surging almost 200% over the last four years. Sound balance sheets, an improved asset market backdrop, and lower loss provisions were the major contributors to this advancement. Admittedly, a lot remains to be done in order to reach the pre-crisis levels, though many appear on their way to these marks.

From a sector perspective, financials have been the star performer in the second quarter with a beat ratio of 76.9% for earnings and 61.5% for revenues (read: 3 Bank ETFs Leading the Pack this Earnings Season). Total earnings for the sector went up 30% on 8.5% higher revenues in the second quarter.

In fact, if we remove finance from the pack of all sectors, the growth picture becomes much weaker in the second quarter on a sequential basis. Coming to discuss the forward scenario, the sector is expected to post 16.9% in earnings growth for 2013 and 8.7% in revenue growth for 2014.

Also, financials have accounted for the largest increase in dividends in the last three years, making them an intriguing income play to top things off (Read: 2 Sector ETFs Surging This Earnings Season).    

Given this bullish trend, a look at some of the top ranked ETFs in the space could be a good way to target the best of the segment with lower levels of risk. Investors looking to tap this segment in basket form can invest in the Vanguard Financials ETF (VFH - ETF report) which is a Zacks ETF Rank #1 (Strong Buy) fund with a ‘Low’ risk outlook. We expect it to outperform its peers over the next year, and to continue posting solid returns heading into the end of 2013.

About the Zacks ETF Rank

The Zacks ETF Rank provides a recommendation for the ETF in the context of our outlook for the underlying industry, sector, style box or asset class (Read: Zacks ETF Rank Guide). Our proprietary methodology also takes into account the risk preferences of investors. ETFs are ranked on a scale of 1 (Strong Buy) to 5 (Strong Sell) while they also receive one of three risk ratings, namely Low, Medium or High.

The aim of our models is to select the best ETFs within each risk category. We assign each ETF one of the five ranks within each risk bucket. Thus, the Zacks ETF Rank reflects the expected return of an ETF relative to other products with a similar level of risk.

For investors seeking to apply this methodology to their portfolio in the financials space, we have taken a closer look at the top ranked VFH. This ETF has a Zacks ETF Rank of 1 or ‘Strong Buy’ (see the full list of top ranked ETFs) and is detailed below:

About VFH
 
Investors poised to ride on the present uptrend in the financial market could find Vanguard Financials ETF (VFH - ETF report) – launched in January 2004 – an exciting pick. The fund tracks MSCI US Investable Market Financials 25/50 Index.
 
With an asset base of about $1.5 billion, VFH is among the largest ETFs covering the U.S. financials sector. The fund offers ample liquidity with average trading volume of 240,000 shares moving hands each day (see more in the Zacks ETF Center). It is also a cost effective option for investors as it charges just 19 bps in fees which is much lower than the category average of 47 bps.
 
The fund holds a fairly large portfolio of about 536 securities. Top companies include Wells Fargo & Co., JPMorgan Chase and Bank of America all of which together account for around 18% the assets. The concentration level in the top 10 holdings is moderate at 36.9%. In terms of industry breakdown, banks, REITs, financial services and insurance take the top four spots at about 20% of assets invested in each.
 
Desired diversification and more then 70% exposure to large cap stocks lower the fund’s risk quotient. As such, we have a ‘Low’ risk outlook for VFH in the near term, although lower risk does not mean lower returns in many cases.
 
VFH has fetched about 27.29% in returns over the one-year period ended September 30, 2013, which is roughly 800 basis points higher than SPDR S&P 500 ETF (SPY) over the same period (read: 6 ETFs Beating the Market Over the Past Year). In the year-to-date frame the fund saw 18% return.
 
The fund is currently trading close to the higher end of its 52-week range of $31.45-$42.86. VFH pays out a yield of 1.98% per annum.
 


The ETF currently has a Zacks ETF Rank of 1 or ‘Strong Buy’ with ‘Low’ risk outlook, suggesting that it is positioned to outperform similar competitors in the future as well (read: Zacks ETF Rank Guide).

Bottom Line
 
While the picture is presently a bit dicey thanks to the unanticipated ‘Taper Hold’ that again pushed the interest rate down thus creating a little hitch for banking stocks, we expect, sooner or later, at least a soft taper will be put into action.
 
Secondly, since about 20% of the fund’s holding is in REITs – an interest rate sensitive sector – it would likely benefit from the ‘Taper Hold’ as long as interest rates remain low.  

All top three companies-- Wells Fargo & Co., JPMorgan Chase and Bank of America-- reported sound earnings last season, and could be well-positioned this time around as well. Lower provision for credit losses, improved brokerage income and compelling investment banking business are the major strength.

Given this, there is reason to be bullish all around for this ETF, suggesting that both the near term future and the long term path could be very bright for investors in VFH.
 
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