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Rate Hike Bets Spurred August Inflows To Financial ETFs

SPDR Financial Select Sector Fund ETF ETF:XLF, Vanguard Financials ETF - DNQ ETF ETF:VFH - Rate Hike Bets Spurred August Inflows To Financial ETFs

Fed fund futures now say traders are paring bets that the Federal Reserve will raise interest rates later this month; but in August, inflows to financial services exchange-traded funds indicated otherwise.

Financial services, the S&P 500's second-largest sector allocation behind technology, is lagging the benchmark U.S. equity index this year, as investors have become frustrated with the Fed's vague guidance regarding when borrowing costs will move higher. For example, the Financial Select Sector SPDR Fund XLF 0.08%, the largest financial services ETF, is up 4 percent year-to-date, while the S&P 500 is higher by 8.5 percent.

Focusing On Financials

“S&P Global Market Intelligence banking equity analyst Erik Oja thinks higher interest rates would be a positive for many companies he follows particularly the largest US banks, which have a lot of short-term investments which immediately benefit. For example, by his calculations, revenues for JPMorgan Chase & Co. JPM 0.13% were aided by $220 million in the first quarter of 2016 due to the December 2015 rate hike. Regional banks benefit more when market-driven long-term rates rise,” said S&P Capital IQ in a note out Wednesday.

XLF's primary rival, the Vanguard Financials ETF VFH 0.08%, added nearly $502 million in new money last month, while XLF saw August inflows of over $471 million. S&P Capital IQ has overweight ratings on XLF and VFH and a four-star rating on Dow component JPMorgan, the largest U.S. bank by assets.

As S&P Capital IQ notes, there are important differences between XLF and VFH.

XLF And VFH Are Not The Same

“VFH includes small- and mid-cap companies not inside the S&P 500 index and in addition at the beginning of September it sold its stake in REITs as part of the GICS changes that created an 11th sector. XLF plans to pay a special dividend equal to its REIT exposure to shareholders in mid-September when the S&P 500 index rebalances,” said the research firm.

As was recently noted in this space, the SPDR S&P Insurance ETF KIE 0.44% has been one of the best-performing financial services ETFs this year even with no help from the Fed. However, investors took profits in KIE last month.

“KIE incurred $61.4 million in net outflows, narrowing year to date inflows to $10.6 million,” noted S&P Capital.

Still, KIE has outpaced XLF and VFH year-to-date.

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Disclosure: Todd Shriber owns shares of XLF.

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