IAI - IAI: More A Signal Than An Investment Now

2023-11-15 05:22:27 ET

Summary

• Broker-Dealer and Exchange stocks have held up well compared to other Financial sector stocks.
• The iShares U.S. Broker-Dealers & Securities Exchanges ETF tracks the performance of the Dow Jones U.S. Select Investment Services Index.
• Investing in broker-dealers, securities exchanges, and investment banks can provide exposure to the broader economy and steady revenue streams.

Candidly I'm surprised that Broker-Dealer and Exchange stocks have held up so well relative to other stocks in the Financial sector. I often track the space more as a signal of market activity broadly. It's not one I'd invest in however. To that end, it's worth keeping an eye on the iShares U.S. Broker-Dealers & Securities Exchanges ETF ( IAI ) to get a sense of market expectations for future activity and broader economic health.

IAI is an ETF that seeks to track the performance of the Dow Jones U.S. Select Investment Services Index. It primarily invests in U.S. equities in the investment services sector, with a specific focus on broker-dealers, securities exchanges, and investment banks. The fund was launched on May 1, 2006, and has a management fee of 0.40%. As of November 10, 2023, it had net assets of approximately $382 million.

Investing in the stocks of broker-dealers, securities exchanges, and investment banks can be beneficial for a few reasons. Broker-dealers earn income from trading commissions, the spread on securities, and underwriting securities, which can provide steady revenue streams during varying market conditions. Securities exchanges earn money from transaction and listing fees and selling data, providing a diversified income stream and stability. Investment banks generate revenue from advisory fees for mergers and acquisitions and capital raising, underwriting fees, and proprietary trading, allowing them to profit from high-value transactions. Investing in these financial institutions can provide exposure to the broader economy as their performance tends to correlate with economic growth.

ETF Holdings: A Closer Look

Understanding the holdings of an ETF is crucial as it gives investors an insight into the fund's exposure and risk profile. These top five holdings, make up approximately 49% of the overall fund.

• S&P Global Inc (SPGI) is a leading provider of ratings, benchmarks, analytics, and data to the capital and commodity markets worldwide. It accounts for about 15.28% of total assets in IAI.
• Goldman Sachs ( GS ) is a leading global investment banking, securities, and investment management firm. It constitutes approximately 12.79% of IAI's total assets.
• Morgan Stanley ( MS ) is a global financial services firm providing investment banking, securities, wealth management, and investment management services. It makes up about 11.45% of the total assets of IAI.
• CME Group ( CME ) is the world's leading and most diverse derivatives marketplace, and it constitutes around 4.84% of the total assets of IAI.
• Charles Schwab (SCHW) is a leading provider of financial services, with more than 360 offices and 12.5 million active brokerage accounts. It accounts for roughly 4.39% of IAI's total assets.

Sector Composition and Weightings

The fund's exposure is skewed towards Financial Exchanges & Data, with Investment Banking & Brokerage making up the rest.

This is primarily a large-cap fund, but does have some good exposure to mid and small-cap names which I personally favor tilting towards given how poorly most stocks have done in that market cap range.

Peer Comparison

One of the main competitors to IAI is the SPDR S&P Capital Markets ETF ( KCE ). KCE tracks the S&P Capital Markets Select Industry Index and offers exposure to the same sector as IAI. However, there are significant differences in the expense ratios, performance, and risk profiles of these two ETFs.

KCE has an expense ratio of 0.35%, slightly lower than IAI's 0.40%. In terms of performance, IAI showed a better return compared to KCE in both the one-year and three-year periods. However, IAI has a higher beta and standard deviation, indicating a higher risk compared to KCE.

When we look at the ratio of IAI to KCE, we can see IAI looks set to outperform on a relative basis.

Conclusion: To Invest or Not to Invest?

IAI can be a good choice for investors who are bullish on the sector's outlook and are willing to take on a higher level of risk. However, given a potential looming recession and corporate credit event, it's not one I'd favor here. If anything, it's one I would watch to potentially confirm if the risks I've been highlighting are starting to get priced in. The more recent sideways action may be telling in that regard.

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