The year 2022 came as a shock. After the historic lows of 2020 and a strong rebound of 2021, last year was not expected to be a volatile one. But a war in Ukraine, a fresh COVID wave in China and the resultant lockdown, and various other macroeconomic factors paved the path for four-decade-high inflation, which was not foreseen.

In a desperate bid to control inflation, the Federal Reserve started raising rates in March. Starting with 25 bps, the rate-hiking spree reached its crescendo with four consecutive 75 bps hikes. The streak came to a halt in the Fed’s December Federal Open Market Committee meeting, wherein a 50 bps hike was announced. But Fed officials have been hawkish enough to indicate that rate hikes will continue well into this year.

The December hike took the borrowing rate to a targeted range between 4.25% and 4.5% — the highest level in more than 15 years. Fed projections show that interest rates will rise to as high as 5.1% in 2023 before ending its fight against inflation. This is higher than the 4.6% projected by the Fed in September.

For 2024, the Fed sees the rates correcting down to 4.1%, again, higher than what was projected in September. But regardless of these numbers, what is more ominous for the markets is that Fed officials are simply not guaranteeing an end to this cycle as yet. Rather than turning dovish, they are stating a grim fact that rate hikes will continue till inflation is truly and completely under control.

“The historical record cautions strongly against prematurely loosening policy. We will stay the course, until the job is done,” were Fed Chair Jerome Powell’s words after the December meeting. Economic data released since then have reassured investors somewhat that the Fed might be inferring that its policies have started taking effect and cut a slack in the pace of rate hikes, but if Powell’s words are a clue, they will continue to rise, albeit at a slower pace. As late as on Jan 10, Powell warned against populist policies that might be pushed by the political class.

"Restoring price stability when inflation is high can require measures that are not popular in the short term as we raise interest rates to slow the economy. The absence of direct political control over our decisions allows us to take these necessary measures without considering short-term political factors," Powell said.

As interest rates go up, the banking sector and other financial institutions that have cash holdings from customers and other business activities generally see higher profitability due to increased lending rates. The gap between such lending rates is considered to be long-term assets for banks, and short-term liabilities, such as deposits, increase, thereby boosting net interest margins. Stocks of banks, insurance companies, and other financial institutions rise in periods of continued interest rate hikes.

In summary, financial mutual funds provide the much-required growth in a market where interest rate hikes are expected to continue. Hence, astute investors should consider such funds at present. Mutual funds, in general, reduce transaction costs and diversify portfolios without an array of commission charges that are mostly associated with stock purchases (read more: Mutual Funds: Advantages, Disadvantages, and How They Make Investors Money).

We have thus selected three financial mutual funds that boast a Zacks Mutual Fund Rank #1 (Strong Buy) or 2 (Buy), have positive three-year and five-year annualized returns and minimum initial investments within $5000 as well as carry a low expense ratio. We have also made sure that at least 80% of the fund is invested in the financial sector.

Fidelity Advisor Financial Services Fund (FAFDX Quick QuoteFAFDX - Free Report) seeks long-term growth of capital by investing the majority of its net assets in common stock issued by companies engaged in providing financial services to consumers and industry. FAFDX uses fundamental analysis of factors such as financial condition and industry position, as well as market and economic conditions to decide its investments.

Matt Reed has been the lead manager of FAFDX since May 31, 2019, and 85.4% of the fund is invested in the financial sector. Three top holdings for FAFDX are 5% in Wells Fargo, 5% in Bank of America, and 4% in M&T Bank.

FAFDX’s 3-year and 5-year annualized returns are 9.6% and 7.9%, respectively. Its net expense ratio is 1.03% compared to the category average of 1.08%. FAFDX has a Zacks Mutual Fund Rank #1. To see how this fund performed compared to its category, and other 1 and 2 Ranked Mutual Funds, please click here.

T. Rowe Price Financial Services Fund (PRISX Quick QuotePRISX - Free Report) seeks long-term growth of capital and a modest level of income. The fund invests the majority of its net assets in common stocks of companies in the financial services industry. PRISX also invests in companies deriving substantial revenues from conducting business with the industry, such as providers of financial software, and offers dividends and capital gains annually in December.

Matt Snowling has been the lead manager of PRISX since Jul 1, 2021, and 87.4% of the fund is invested in the financial sector. Three top holdings for PRISX are 4.8% in Wells Fargo, 4.4% in Chubb Limited and 3.5% in Bank of America.

PRISX’s 3-year and 5-year annualized returns are 12% and 10%, respectively. Its net expense ratio is 0.83% compared to the category average of 1.08%. PRISX has a Zacks Mutual Fund Rank #1.

Fidelity Select Brokerage and Investment Management (FSLBX Quick QuoteFSLBX - Free Report) invests the majority of its assets in common stocks of companies principally engaged in the exchange of financial instruments, stock brokerage, commodity brokerage, investment banking, tax-advantaged investment or investment sales, investment management, or related investment advisory and financial decision support services. FSLBX offers dividends and capital gains twice a year in April and December.

Charlie Ackerman has been the lead manager of FSLBX since Oct 31, 2018, and 87.6% of the fund is invested in the financial sector. Three top holdings for FSLBX are 6% in S&P Global, 5.8% in BlackRock, and 5.7% in LPL Financial.

FSLBX’s 3-year and 5-year annualized returns are 15.3% and 11.7%, respectively. Its net expense ratio is 0.74% compared to the category average of 1.08%. FSLBX has a Zacks Mutual Fund Rank #2.

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