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Beware These Three Volatile Financial ETFs

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While the market continues to churn higher in 2012, financials remain one of the riskiest sectors for a variety of reasons. The PIIGS debt debacle remains an ever present worry and with concerns beginning to build over Spain we could see more volatility in the sector in months ahead.

Despite this, financials have easily been one of the best performing sectors in the market so far this year, outpacing the returns of many of the more stable counterpart industries. From a U.S. perspective, the Financial SPDR (XLF - Free Report) is currently the best performing sector ETF in year-to-date terms, crushing the S&P 500 by nearly 750 basis points in the time frame (see Three Financial ETFs Outperforming XLF).

However, when looking at the trailing 52 weeks instead, financials are among the three worst performers only beating out energy and materials over the past year. This suggests that financials continue to be an extremely volatile sector and that the space can often be one of the biggest movers in a specific time frame.

This trend can be even more magnified when investors look to the international space instead. This is because these securities can have more exposure to European markets or have a greater focus on emerging economies. In either case, they can experience greater levels of movement then their U.S. large cap focused peers.

Thanks to this, these securities can make for interest plays on an economic recovery or an increase in risk appetite across the board. However, they can also big losers when markets turn south, suggesting that these volatile securities can be interesting picks for traders in the financial ETF space (read Top Three High Yield Financial ETFs).

For investors seeking to make a play on this risky segment of the market—either long or short—a closer look at some funds which have high standard deviation levels could be in order. These funds tend to move much more than their peers and thus can be some of the biggest winners—or losers—when markets are experiencing outsized levels of volatility.

PowerShares KBW International Financial Portfolio

This ETF tracks the KBW Global ex-U.S. Financial Sector Index which is a benchmark of global companies that are engaged in the business of providing financial services and products across a variety of business lines. Currently, the ETF holds 57 securities in its basket and charges investors 40 basis points a year in fees.

The financial ETF has a one year standard deviation of 54.83%, nearly sixty percent higher than XLF’s metric. This comes despite the fund focusing heavily on blend securities and large caps from a variety of developed and emerging nations.

The volatility is likely coming from the significant European allocation in the fund as the continent makes up close to 40% of the total. This is led by a 13% allocation to Spain and a 10% holding in British financial institutions as well (read Three Low Beta Sector ETFs).

So far in 2012, the ETF has gained a respectable 11%, although this performance has been less impressive than others in the space. However, the ETF does pay out a solid yield of nearly 2.7%, comparable to other financial ETFs.

iShares MSCI Far East Financials Sector Index Fund

This ETF gives investors concentrated exposure to the financial segment of companies based in the Far East. The product has close to 78 holdings in its basket and it charges investors 48 basis points a year in fees.

Like other products on the list, the one year standard deviation for this fund is above 50%, signaling high levels of volatility. This is somewhat surprising given the product’s focus on large caps and value stocks which comprise the bulk of the portfolio (see Five Cheaper ETFs You Probably Overlooked).

Furthermore, the countries that the fund focuses on are pretty strong and developed as Japan (57%), Hong Kong (21%), and Singapore (13%) take the top three spots. However, this also pushed the fund into securities denominated in a variety of currencies including nearly 60% in yen. Thanks to this and the volatility of the currency market as of late, it shouldn’t be too surprising that the fund has such a high standard deviation.

Furthermore, investors should note that the product has a heavy component in the real estate segment, as close to one-fourth of total assets goes to this space. Beyond this, however, there is close to 40% in banking and 14% in insurance firms, suggesting a reasonable mix of firms.

This financial ETF has performed quite well so far in 2012, adding nearly 21.2% in the time period. This, along with the 30 Day SEC Yield of 4% compares favorably to many other internationally-focused ETFs in the space. Unfortunately, the volume on this fund is quite low, suggesting extremely wide bid ask spreads for all investors. 

iShares MSCI ACWI ex-US Financials Sector Index Fund

For a broad look on financials outside of the U.S., iShares’ AXFN makes for an intriguing choice. The ETF charges investors 48 basis points a year and holds about 260 stocks in its basket, by far the most on this list (see more on the Zacks ETF Center).

Once again, this ETF has a one year standard deviation over 53%, suggesting high levels of volatility on a regular basis. This comes despite a majority of the assets going towards value stocks as well as those that are in the large cap space.

The risk probably comes from the heavy European exposure (40%) and the decent amount of emerging market assets. In fact, China finds its way into the top five along with the UK, Canada, Australia, and Japan. Additionally, the U.S. dollar makes up just 12% of the holdings, implying that foreign currency risks are a major concern for investors in this fund.

In terms of performance, the product has added about 11.4% although it is currently trading at a 2.9% discount on extremely low volume. This produces wide bid ask spreads although the 30 Day SEC yield of 3.3% is likely to provide some comfort to those who are long this ETF.

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