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Buy 4 Financial Mutual Funds as Fed Officials Back Rate Hike

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Fed’s vice chair Stanley Fisher deems conditions favorable for a rate hike in the near term, with the Fed remaining close to hitting its target for full employment and 2% inflation. New York Fed President William Dudley advocates a rate hike in September, while more than a few Fed officials from Atlanta Fed President Dennis Lockhart to San Francisco Fed President John Williams sounded hawkish.

Needless to say, the Fed’s minutes from the July meeting showed that a rate hike is soon to come. Possibility of a hike bodes well for the financial sector which makes it the ideal time to invest in mutual funds exposed to such a sector.

Vice Chairman Adopts Hawkish Stance

Fisher recently stated that a rate hike this year is still under consideration. He provided an encouraging assessment of the economy’s current strength, with the job market nearing full employment. July’s nonfarm payrolls steered past analysts’ expectations by 255,000 job additions, which followed an upwardly revised 292,000 jobs in June, according to the Labor Department. Fed Chairwoman Janet Yellen had already said that the economy needs to create around 100,000 jobs to attain full employment levels (read more: 5 Stocks to Buy on Encouraging Employment Data).

Fisher did mention that the economy is moving toward achieving its 2% inflation target. According to him, the Fed’s preferred price benchmark minus food and energy cost is at 1.6%, which was “within hailing distance of 2 percent”.

Dudley Says September Rate Hike Likely

Dudley said that “we are edging closer towards the point in time when it will be appropriate to raise rates further”, warning investors that they are underestimating the likelihood of an increase in borrowing costs.

Investors are currently anticipating only one rate hike between now and the end of the year, according to federal funds futures contracts. However, Dudley says that such expectations are “too low” and that “the market is complacent about the need for gradually snugging up short-term interest rates over the next year or so.”

When asked as to whether the Fed should raise rates in the next meeting in September, Dudley said “I think it’s possible”.  He believes that economic growth in the second quarter will be much stronger than the first quarter while the labor market will continue to tighten.

Several Officials Hint at Rate Hike this Fall

Quite a few Fed officials expect a rate hike this fall. Lockhart said that he’s confident that growth is accelerating, which will eventually set the stage for one or two rate increase this year. Williams too foresees another interest-rate hike “sooner rather than later”.

Fed officials were split in July over the urgency to raise rates, with some preferring to play the waiting game and others believing that a strengthening labor market and diminishing near-term risks to the economy call for a rate hike (read more: Fed Officials Split in July on Whether Rate Hike Needed Soon).

Financial Sector to Gain

The finance sector that comprises several industries including insurance, banking, brokerage and asset managers tend to benefit from rate hikes. Banks benefit from a steep yield curve, i.e. when the spread between long-term and short-term rates is wide. The interest rates on deposits are usually tied to short-term rates while loans are often tied to long-term rates. This means that the potential rise in rates will enable the banks to charge more for loans, leading to an increase in the spread between lending rates and the rates paid on deposits (read more: Are Banks More Profitable When Interest Rates Are High or Low?).

Insurance companies invest majority of the premium income received from policyholders in government and corporate bonds. A rise in rates will enable insurance firms to invest in higher yielding government securities, thereby leading to greater returns. Brokerage firms and asset managers benefit immensely from rising-rate environments since increase in rates generally concur with periods of economic strength and investor enthusiasm (read more: Which Investments Could Benefit From Rising Interest Rates?).

Rate Hike in the Cards: Play 4 Financial Mutual Funds

Given the optimism shown by top Fed officials about chances of a rate hike, it will be prudent to invest in mutual funds having significant exposure to the financial sector. As mentioned above, almost all the industries that constitute the financial sector stand to benefit from a rise in rates (read more: 6 Regional Bank Stocks to Buy as Rate Hike Prospects Rise).

But, why mutual funds? This is because funds reduce transaction costs and diversify portfolios for investors without the several commission charges that stocks need to bear (read more: Mutual Funds: Advantages, Disadvantages, and How They Make Investors Money).

We have picked four such financial mutual funds that possess a Zacks Mutual Fund Rank #1 (Strong Buy) or 2 (Buy), have positive 3-year and 5-year annualized returns, minimum initial investments within $5000 and low expense ratios.

JHancock Regional Bank A (FRBAX - Free Report) invests a large portion of its net assets in equity securities of regional banks and lending companies. FRBAX’s 3-year and 5-year annualized returns are 10.6% and 19.8%, respectively. FRBAX has a Zacks Mutual Fund Rank #2 and an annual expense ratio of 1.26%, which is lower than the category average of 1.46%.

Fidelity Select Insurance Portfolio (FSPCX - Free Report) invests the majority of its assets in securities of companies principally engaged in selling of property and casualty, life, or health insurance. FSPCX’s 3-year and 5-year annualized returns stand at 11.3% and 18.5%, respectively. FSPCX has a Zacks Mutual Fund Rank #1. The fund’s annual expense ratio is 0.8%, below the category average of 1.46%.

Fidelity Select Brokerage & Investment Management (FSLBX - Free Report) invests a large portion of its assets in securities of companies principally engaged in stock brokerage or related investment advisory services. The fund’s 3-year and 5-year annualized returns are 2.3% and 12.3%, respectively. FSLBX has a Zacks Mutual Fund Rank #2. FSLBX has an annual expense ratio of 0.78%, which is lower than the category average of 1.46%.

Franklin Mutual Financial Services A (TFSIX - Free Report) invests a major portion of its net assets in securities of financial services companies. TFSIX’s 3-year and 5-year annualized returns are 7.9% and 11.8%, respectively. TFSIX has a Zacks Mutual Fund Rank #2. The fund’s annual expense ratio is 1.41%, lower than the category average of 1.46%.

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