Regional ETF Survey
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Friday, March 31st, 2006
ETF Bank Shot in Right Pocket
Banks and other financial services companies are trading at attractive levels. According to recent data from Mercer Oliver Wyman, the US financial services group trades at a 33% discount to the S&P 500 index. European banks are trading at less of a discount but regional differences are becoming less important as the big boys are really a play on global growth.
During my first job at the Bank of Boston, I noticed that the bank's profitability and stock price waxed and waned with the fortunes of the New England economy. In effect, the bank's stock served as an index fund for the regional economy which at that time was dominated by the cyclical technology industry.
Investing in strong banks to tap economic growth in a country or region is a simple and time tested strategy that can lower your risks, especially in emerging markets. The dean of global investing Sir John Templeton used investments in banks as proxies for gaining exposure to undervalued stock markets around the world. By no means does this strategy always work and unexpected events and the dramatic changes in how most banks make money have made it far less effective. There are also new investment tools such as ETFs that allow investors to play all the angles of bank proxy investing.
The logic of bank proxy investing goes something like this. Banks have broad and deep tentacles into a national or regional economy through their loans to companies and individuals. A pick up in economic growth leads to an increase in loan demand, higher levels of interest income and lower levels of non-performing loans. Assuming solid management and a good balance sheet, this should lead to a jump in profitability and stock price. To use a billiards analogy, investing in banks as a proxy for anticipated economic growth in a country is like a bank shot whereby a ball is driven into a cushion before it is pocketed. It is a soft indirect shot that requires careful preparation and finesse.
My favorite global banking play is HSBC (HSBC). Founded in 1865 as Hong Kong and Shanghai Banking, as recently as twenty years ago 75% of its profits were from Hong Kong. Now it is far more balanced with 36% of its profits attributable to the U.S., 32% from Hong Kong, 18% from the UK and 16% from the rest of the world.
Management is also looking ahead. Last year, the retiring Chairman John Bond hosted the bank䴜s board in Bombay and Delhi. With assets of $1.5 trillion, 115 million customers and 9,700 offices in 77 countries, it is a spectacular global company. Only Citigroup and Bank of America (90% of profits from the U.S.) have larger profits.
A simpler more diversified approach is to invest in financial services exchange-traded funds (ETFs). The iShares Dow Jones Financial Services ETF (IYG) is up 12.9% over the last twelve months and the iShares S&P Global Financials ETF (IXG) is up 18.5%.
Even better, layer a couple of specific picks such as HSBC and Bank of America (my favorites) over these sector ETFs for the best of both worlds.
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