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Top Ranked Financial ETF in Focus: FXO

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If it wasn't for the Finance sector, second quarter earnings season would have been rather disappointing. The financial sector, which was one of the best performing segments in 2012, continued with its impressive performance this year, adding on to its recent bullish trend.

Owing to robust earnings from the banking sector, investor confidence has received a boost as well. In fact, the financial sector has seen earnings growth of +30% year-over-year in Q2. The sector could maintain its relative strength attributable to strong banking numbers from most of the top stocks in the space (Read: 2 Sector ETFs Surging This Earnings Season).

However, the taper postponement by Bernanke has caused trouble for the financial sector, while there have also been concerns over revenues as well. This was witnessed when Citigroup took a dip by almost 3.2% which led to some rough trading in a number of companies in the space (Read: Financial ETFs Tumble on Citigroup Warning).

This news led to some modest losses for a number of companies in the sector, sending industry share prices down several percentage points on the session. In particular, many financial sector ETFs were the hardest hit by Citigroup’s news.

For now we have chosen an ETF which currently has a Zacks ETF Rank of 1 or ‘Strong Buy’ and may prove to be a safe haven during these troubled times, and a better play on the strong parts of the financial sector:

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 financial sector, we have taken a closer look at the top ranked First Trust Financials AlphaDEX Fund (FXO - Free Report) . 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 FXO

Launched in May 2007, FXO tracks the Strata Quant Financial AlphaDEX Index, which is a modified equal-dollar weighted index. The benchmark is designed by NYSE Euro-next to objectively identify and select stocks from the Russell 1000 Index in the financial services sector that may generate positive alpha relative to traditional passive-style indices through the use of the AlphaDEX selection methodology.
The ETF holds about 169 securities in its basket. The fund is well spread across individual holdings as it does not put more than 12% in its top 10. FXO does well in eliminating concentration risk as it does not allocate too much in any single component.
Nationstar Mortgage Holdings, Ocwen Financial Corporation and FleetCor Technologies are the top 3 holdings of the fund. FXO does not allocate more than 1.5% allocation across individual holdings (Find all Financial ETFs).
From an industry exposure perspective, Insurance leads with 36.44% allocation while Commercial Banks, Capital Markets and IT Services together make up 37%.
FXO currently has an asset base of $450 million and on an average does a daily volume of about 249,000 shares. It also pays out a paltry yield of 1.69% (see more in the Zacks ETF Center).
FXO has played quite a significant role in the financial ETF world by delivering notable returns. The fund has given sturdy returns of about 23.9% year to date. In fact, the product is hovering well above its 200-day moving average of $18.33.
The product, however, is a little costly as it charges a high 70bps in fees due to its innovative fund management technique. The fee is much higher than the category average of 47bps.
The Bottom Line
While many may still have concerns over the financial sector’s upswing, especially after the 2008 financial crisis, financial ETFs by applying a diversified approach not only in the U.S. but also across various financial institutions globally, offer a great way to play the sector (Read:3 Sector ETFs to Watch for the Budget Battle)..
Given that the financial sector should continue with its strong momentum and its dominant role in the broad markets, FXO is poised to benefit and may see more room for upside going into 2013's home stretch.
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