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Surprise bulletin for ETF investors: Beware the infestation of financial stocks.
As thoroughly as financial stocks have been trounced of late, they’re still a dominant presence in many indexes that are tracked by exchange-traded funds. Quick examples: the iShares CDN Dividend Index Fund (XDV-TSX) had a whopping 64.7-per-cent weighting to financials as of mid-March, while the new Claymore 1-5 Yr Laddered Corporate Bond Index ETF (CBO-TSX) was 53-per-cent weighted to the sector.
Financials have been the third-worst performing sector in the S&P/TSX composite index over the past 12 months, falling 38.5 per cent. The sector’s 50-per-cent cumulative decline over the previous three years ranks it worst. And yet, financials continue to dominate certain stock and bond indexes.
In the S&P/TSX composite index itself, financials are the second-ranked sector behind energy with a weighting of 27.5 per cent. But the preponderance of financial stocks among issuers of dividend-paying common shares, preferred shares and corporate bonds means you can expect lots of bank, insurance and fund company names in more specialized indexes.
Take preferred shares, for example. The index tracked by the Claymore S&P/TSX Preferred Share ETF (CPD-TSX) is 81.5 per cent tilted to financials. There are names like Fortis and Brookfield Asset Management in the index as well, but they’re overshadowed by names like Great-West Lifeco, Canadian Imperial Bank of Commerce and IGM Financial. Corporate bonds are much the same story. Financials account for 53.9 per cent of the iShares CDN Corporate Bond Index Fund (XCB-TSX), pretty much the same as a competing Claymore fund.
Watch for financials in some broader ETFs as well. The Claymore Canadian Fundamental Index ETF (CRQ-TSX) tracks an index with a 42.3-per-cent weighting in financials. Five of the top six holdings are big banks.
Some market watchers say the next big surge in the stock markets will be led by financials, and it’s worth noting that the S&P/TSX capped financials index jumped 17 per cent in the second week of March alone. Still, there’s reason to be wary of financials as the recession unfolds and loan losses grow. If that worries you, watch out for financial exposure in a lot of ETFs where you might not have expected to find it.