2023-03-31 18:59:40 ET
Summary
- Invesco S&P 500 Equal Weight Financials ETF is the same portfolio as the more popular XLF, except that it weights its holdings equally.
- If there was ever a time to consider financials in an equal-weighted fashion, it is right now. It cuts single stock risk.
- I rate the RYF ETF a Hold, only because of the fragile nature of financials right now. When that dust settles, I expect to upgrade it.
I rate Invesco Exchange-Traded Fund Trust - Invesco S&P 500 Equal Weight Financials ETF ( RYF ) a Hold. Though some are speculating that the major headwinds of recent banking crises are receding, I believe the financial sector is not yet in the clear. Furthermore, recent events could have more long-term implications for banks and the financial sector alike. Therefore, for RYF and similar funds, it might be wise to proceed with caution in coming periods.
The 2023 banking crisis is in its early innings, and we do not know how many more shoes to drop. So for those who do want to dip their toes into the sector at a time when risk is very high, I suggest considering RYF. This exchange-traded fund, or ETF, does not focus as much on investment banks and other corporate institutions compared to similar alternatives like the Financial Select Sector SPDR ETF (XLF).
Taking some of the risk out of investing in financial stocks now
Unlike its much bigger peers, this ETF does not carry the concentration risk that comes with having 10-15 stocks drive performance of the entire portfolio. I normally prefer concentrated ETFs, but not in this sector, at this moment in history. In fact, many are settling for safety rather than excessive returns at the moment, which could make RYF more attractive as macroeconomic risks loom.
There's more to financial stocks than banks, credit cards, and Buffett
Many cap-weighted financial sector ETFs crowd into the mega-cap banks, brokers, credit card companies and Warren Buffett's corporate creation. RYF owns the same holdings, but the equal weighting aspect makes it far less dependent on the success of a small number of huge stocks.
Despite its dispersed holdings composition, this ETF is still quite volatile and saw a larger decline than that of XLF following the bank failures at the beginning of March. Therefore, just because the majority of its holdings aren’t situated directly on Wall Street doesn’t make it immune to financial crises.
The recent series of bank runs centered on Silicon Valley Bank of SVB Financial Group (SIVB) elicited a sharp decline in this ETF, which it is only beginning to recover from. Though many financials ETFs like RYF were not directly affiliated with recent crises, these events still sent shockwaves through the financial sector. Therefore, it’s evident that RYF is still somewhat procyclical.
Recent bank runs, bank failures and bank bailouts may turn out to be isolated events. No one knows that right now. However, this debacle could have reflected greater systemic issues within the banking industry. Therefore, the financial sector could be in for some policy tightening and increased scrutiny. In particular, regional banks could experience higher funding costs and increased credit standards in the future. Both of these developments could reduce the profitability of banks and even hinder the growth of new companies and startups. This could threaten the profits of some companies held in this ETF and potentially bite into investors’ returns.
A strong consideration for those who recognize the appeal of equal-weighted ETFs
RYF has mostly outperformed XLF and the broader market during the last three years, and its net profit is only slightly lower than that of the SPDR S&P 500 Trust ETF (SPY). Though recent events have not been kind to this ETF, it could possess some fundamental edges that one can only reap the benefits of if they hold it for long enough. Investing in RYF might therefore require a certain amount of patience and trust that conditions will favor this fund in the long term.
This ETF’s returns also surpassed that of the S&P 500 (SP500) during October 2022, when rate hikes became especially aggressive . In the future, RYF could potentially outperform as the greater portion of the market struggles amid inflation pressures. This ETF also experienced a larger decline than that of both the S&P 500 and XLF in response to recent financial crises. This outlines a specific vulnerability that one likely won’t find in most non-financial sector ETFs.
Price trend analysis
This chart below displays that RYF is in a similar predicament as many parts of the market that are not FAANG-oriented: it is at risk of a breakdown that would erase all of its price gains since early 2021.
My favorite momentum indicator, the PPO shown in the bottom half of the chart, has broken below the zero line. This indicates a change in momentum, and it's not a bullish one.
Though I take a neutral stance right now, this ETF’s price could increase in the near future amid investors buying the dip and exploiting others’ overly-cautious behavior. Buying low has so far been observed mainly by banking insiders . This could indicate that societies’ response to recent crises might have been a slight overreaction, which only those most knowledgeable of the banking industry knew not to give rise to. Those, like me, who chose to play it neutral might consequently experience lesser profits than those who chose to load up on shares while they were cheap.
This ETF’s price is currently quite low, but that does not mean it can’t sink even lower. Especially with what regional banks and the rest of the financial sector might have in store headline-wise, RYF could still be in danger. Many banks could experience increases of deposit flight and have to grapple with the impact of rising interest rates. Furthermore, many small businesses may reduce their borrowing, which could put banks’ cash flows at risk. This could evidently cause ETFs like RYF to decline further in value.
Investment Opinion
I rate RYF a Hold. The financial sector appears to be in a high-risk, high-reward potential situation, fundamentally and technically. We either get a true, buyable bottom soon, or it falls through like a financial crisis does. So, for now, I'm playing the middle ground. But this RYF ETF is at the top of my watchlist to own when the market has thrown out all the good financial babies with the bathwater.
For further details see:
RYF: A Risk-Managed Way To Play A Recovery In Financial Stocks