On Apr 6, Jerome Powell in his first speech as the Fed Chairman said that the economy has registered strong growth and that gradual rate increases are necessary. Additionally, the incoming New York Fed Chief or Fed Vice-Chair John Williams echoed Powell. Moreover, some of the policymakers now expect not just two but even three more rate hikes in 2018.

The Fed Chair and other key officials gave an encouraging outlook on rate hikes, following which the financial sector is expected to embark on a northward journey. In this context, mutual funds with significant exposure to the financial sector are expected to be strong investments.

Powell, Williams Signal Gradual Increase in Rates

In his first speech on the U.S. economy, the Fed Chief said that after recovering slowly following the Great Recession and financial crisis, economic growth “has now picked up.” While, talking about the pace of rate hikes, Powell said, that a slow pace could “tighten monetary policy abruptly” and eventually “jeopardize the economic expansion.”

On the other hand, faster rate increase may lead inflation to remain below Fed’s desired target of 2% and hence “gradual rate increases is intended to balance these two risks.” Although, Powel did not mention anything about the number of rate hikes this year, unlike in December when four policymakers projected three additional rate hikes, seven policymakers now project three more rate increases in 2018.

Additionally, Williams said, “the process of gradually moving interest rates up” in 2018 and 2019 could be easily carried out and at the same time solid economic growth and “historically low” unemployment rates could be maintained. While, talking about the ongoing trade war, Powell ruled out any near-term impact and Williams said any such developments “don’t add up to a huge effect on the economy” at the moment.

Rising Rate Hike Prospects: Boon for Financials

Following its two-day Federal Open Market Committee (FOMC) policy meeting held onMar 20-21, the Fed raised its key interest rate by 0.25 points under the 16th Chairperson Jerome Powell. The central bank raised its key rate for the sixth time since 2015. Moreover, the Fed also expects two additional rate hikes this year and now three rate hikes in 2019 instead of two.

Additionally, the central bank projects economic growth at the rate of 2.7% in 2018, up from the previous expectation of 2.5%. Further, the growth rate is anticipated to be 2.4% in 2019 — higher than the previous forecast of 2.1%. Stronger growth projection for the economy along with high rate hike chances is definitely good news for financials.

How Does a Rate Hike Benefit Financials?

The high-rate environment bodes well for financial companies including banks, money managers, insurance firms and brokerage companies. Banks derive benefits from a steep yield curve, i.e. when the spread between long-term and short-term rates widen. This means that the potential rise in rates will enable banks to charge more for loans, leading to an increase in the spread between lending rates and the rates paid on deposits.

Also, rising rates reflect an improving domestic economy. Higher economic growth attracts more investments, which in turn are expected to benefit brokerage firms and money managers. For insurance companies, a high-rate environment ensures that their underlying bond investments provide strong returns. 

Buy These 4 Financial MutualFunds

The financial sector performed favorably in recent times following the Fed’s interest rate hikes and Fed Chair’s statement. Market watchers believe that this rally will continue if rates march higher in the coming months of 2018. Financial Select Sector SPDR (XLF)has advanced 5.2% in the last six months. According to Morningstar, the financial mutual fund category one-year returns of 16.4%.

This encouraging backdrop warrants investor focus on four financial mutual funds that boast a Zacks Mutual Fund Rank #1 (Strong Buy) or 2 (Buy). Moreover, these funds have impressive one-year annualized returns. They also have minimum initial investment within $5000 and low expense ratios.

We expect these funds to outperform their peers in the future. Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but also on the likely future success of the fund.

Fidelity Advisor Financial Services Fund A (FAFDX Quick QuoteFAFDX - Free Report) seeks growth of capital for the long run. FAFDX invests a bulk of its assets in securities issued by companies that offer financial services to consumers and industries. The fund invests in securities of both U.S. and non-U.S. companies.  

Fidelity Advisor Financial Services A, managed by Fidelity, has an expense ratio of 1.12%, compared with the category average of 1.46%. Moreover, FAFDX has given an annualized return of 18% in the last one-year period carries and a Zacks Rank #2.

Fidelity Select Consumer Finance Portfolio (FSVLX Quick QuoteFSVLX - Free Report) seeks appreciation of capital. FSVLX invests a large chunk of its assets in securities of companies involved in offering services related to consumer finance. The fund considers financial strength and economic conditions before investing in a company.

Fidelity Select Consumer Finance Portfolio, managed by Fidelity, has an expense ratio of 0.93%, compared with the category average of 1.46%. Moreover, FSVLX has given an annualized return of 18.9% in the last one-year period and sports a Zacks Rank #1.

T. Rowe Price Financial Services (PRISX Quick QuotePRISX - Free Report) seeks both capital growth and current income. The majority of its assets are invested in financial services companies. It may also purchase securities of companies involved in providing financial software. The fund uses fundamental bottom-up analysis in order to select securities.

Managed by T. Rowe Price, this T. Rowe Price Financial Services fund has an expense ratio of 0.85%, compared with the category average of 1.46%. Moreover, PRISX has given annualized returns of 17.7% in the last one-year period and carries a Zacks Rank #1.

Fidelity Select Brokerage & Investment Management (FSLBX Quick QuoteFSLBX - Free Report) seeks capital appreciation. The fund invests a huge part of its assets in common stocks of companies involved in stock brokerage, commodity brokerage, investment banking and other financial services. It invests both in U.S. based and non-U.S. based companies.

Fidelity Select Brokerage & Investment Management, managed by Fidelity, has an expense ratio of 0.80%, compared with the category average of 1.46%. Moreover, FSLBX has given an annualized return of 27.2% in the last one-year period and carries a Zacks Rank #2.

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