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ETF News And Commentary

Even though a threat of yet another widespread global recession has been lurking in the economy, financial stocks have proven to be a solid bet for investors so far this year (read Five Best Performing ETFs (So Far) in 2012).

After a forgettable performance in the last fiscal year, the sector has been one of the major contributors behind the broad market rally. Despite this fact, valuations for many remain at attractive levels suggesting that there could be room for further appreciation.

Also, the implementation of quantitative easing 3 (QE3), is expected to give the sector a nice boost by working to restore demand in the economy. This coupled with the continuation of Operation Twist is expected to push down interest rates, thereby further reducing borrowing costs and enhancing credit growth (read Commodity ETFs in Focus as Fed Unleashes QE3).

Having said this, it is also prudent to note that the financial sector is one of the most volatile sectors; therefore a broad based pure play in the sector could go a long way in making the risk-return tradeoff more lucrative for investors. Thus, top ranked Exchange traded funds (ETFs) from the financial sector could be the appropriate bet for investors seeking exposure in this sector.

About the Zacks ETF Rank

A look at top ranked Financial ETFs can be done by using the Zacks ETF Rank. This technique provides a recommendation for the ETF in the context of our outlook of the underlying industry, sector, style box, or asset class. Our proprietary methodology also takes into account the risk preferences of investors as well.

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

Using this strategy, we have found one ETF which is Ranked 1 or ‘Strong Buy’ with this model in the financial sector which we have highlighted in greater detail below:

Guggenheim S&P 500 Equal Weight Financial ETF (RYF)

Launched in November of 2006, RYF tracks the S&P Equal Weight Financials Index. The index includes stocks of those companies which comprise the Financial sector of the S&P 500 Index. However, as opposed to their market capitalization weighing methodology in the S&P 500 index, the components are weighed equally in the S&P Equal Weight Financials Index.

The ETF has an asset base of just $14.11 million, which can be considered low given the fact that the fund has been in existence for around six years. Although the ETF is passive, the fund charges an expense ratio of 50 basis points per year. This can be considered a bit skewed towards the high side especially considering the cheaper options out there (see Does Your Portfolio Need a Financial ETF?).

Also, Guggenheim S&P 500 Equal Weight Financial ETF clearly lacks product visibility and investor appetite as is evident from its poor average daily volume of around 4,500 shares. This in turn, has serious implications on its bid-ask spread ratio which increases the total costs of investing in RYF thereby limiting the realized return potential for investors.

Nevertheless, the ETF has a strong value tilt in its investment style, which paves the way for relatively higher returns than the broader market over the long term. Also, the equal weighing methodology goes a long way in eliminating company/event specific risk for the product, as bigger companies with higher market capitalization (implying more weighting) could distort the overall returns of RYF (see Is It Time For an Equal Weight ETF?).

Not surprisingly, it has a three year annualized standard deviation of 25%, which is low considering that the ETF is a function of the financial sector which is prone to exhibiting higher volatility than other sectors. This is reflected in our risk outlook for RYF as it has earned a ‘Low’ risk outlook along with a Zacks Rank of 1 or ‘Strong Buy.’

From a holdings perspective, the ETF currently holds 81 securities which is exactly equal to the number of financial stocks listed in the S&P 500 Index. The individual weighting of each components vary from 1.31% to 1.08%. Some of its holdings include Progressive Corp., Chubb Corp, Moody’s Corp, M&T Bank Corp, and Allstate Corp (see Best Construction ETF to Ride the Housing Upswing?).

From an industry perspective, the ETF mostly places its bets on Insurance (27.33%), Real Estate Investment Trusts (19.62%), Capital Market Intermediaries (17.01%) and Commercial Banks (16.07%) (see more in the Zacks ETF Center).

RYF has had an excellent run so far this year. It has returned around 19.60% every year-till-date as on 30th September 2012. On a one year basis the ETF is up by almost 33%. After returning almost 20% in the 1st quarter ending March 2012, the ETF slumped in the subsequent quarter fetching negative returns of almost 6%.

Nonetheless, amidst the current positivity of global economic conditions, the ETF has been able to rebound and returned 6.51% for the third quarter ending September 2012. The ETF hit a low of $19.91 and has a 52-week high of $29.65.

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