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By Fund Library News Wire  | Tuesday, July 11, 2017


By Mark Raes, Head of Product, BMO Asset Management Inc.

Investors are always looking for the right sector at the right time to get the maximum possible return with the lowest inherent risk. Finding that perfect investment looks easy in hindsight; however, a properly constructed portfolio that includes sector rotation strategies balancing risk and reward is well positioned to handle developing scenarios. Exchange-traded funds (ETFs) have traditionally been an efficient way to enact these asset allocation strategies, providing wide exposure across a single sector with a single trade.

Industry-based ETFs have taken this a step further, delivering targeted exposure within a given industry, and are seen as particularly valuable in broad sectors, such as financials, where the constituent industries may exhibit divergent returns. Industry-based ETFs are undergoing an evolution in expanding investment options by geographic regions, where investors can now find Canadian, U.S., and global bank ETFs.

Financials, as a growth sector, have exceled through the market recovery since the financial crisis in 2008. Within this sector, banks and insurers are distinct groups with different return drivers. Banks earn profits by lending money at higher rates than they pay on deposits, leveraging their operations, and supplementing earnings by investment banking and other lines of business. Banks are closely aligned with the traditional business cycle: In contractions, bad loans tighten credit; in growth periods, credit expands. In contrast, insurers are cyclically aligned with markets, earning profits based on collecting premiums and investing those premiums in markets and other investments. Insurers look to offset their assumed risks, while subject to both policy risks and investment risks.

Using Canada as an example – and measuring periods from before the financial crisis of 2008, banks have materially outperformed insurance companies. Banks have returned 9.4% annually over the past 10 years, while insurers have returned 2.2% annually over the same period.*

Since the election of President Trump in November 2016, bank stocks both north and south of the Canada-U.S. border have posted strong gains, with U.S. banks among the biggest winners. Following President Trump’s inauguration in early 2017, banks have rallied on the Presidential promise of delivering economic growth and bank reform. The key to sustaining this growth momentum will be President Trump’s implementation of campaign platforms; however, recent stumbles in pushing forward healthcare reform may slow down other proposed changes such as bank reform.

Looking forward, banks are well positioned to have continued strong performance in 2017 based on current expectations for deregulation, lower taxes, increased spending, and higher interest rates. The banking industry has quality companies with strong dividend yields, making them effective long-term investments.

If U.S. interest rates continue to rise, and if other countries gradually follow suit, this will be a further benefit to banks, as it would indicate sustained economic growth leading to wider lending spreads for banks and increased lending opportunities. Banks perform well at the beginning of a rising interest rate cycle, as the yield curve is steep.

BMO ETFs provide investors with the precision to invest in the banking industry. Canadians have always viewed the banks as a key pillar of their portfolios, delivering a high dividend yield with long-term growth. Investing in U.S. banks provides higher growth potential with the added benefit of aligning with evolving U.S. growth expectations. Investing globally provides the additional benefit to North American banking exposure of adding undervalued European banks and other stable international financial companies.

* Source: Morningstar Direct, as of Feb. 28, 2017.

Mark Raes is Head of Product ETF and Mutual Funds, BMO Global Asset Management Inc. This article first appeared in the Spring 2017 issue of Your Guide to ETF Investing, published by Brights Roberts Inc. Reprinted with permission.

Notes and Disclaimer

© 2017 by Fund Library. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited.

BMO ETFs are managed and administered by BMO Asset Management Inc., an investment fund manager and portfolio manager and separate legal entity from the Bank of Montreal. Commissions, management fees and expenses all may be associated with investments in exchange traded funds. Please read the prospectus before investing. Exchange traded funds are not guaranteed, their values change frequently and past performance may not be repeated.

®BMO (M-bar roundel symbol) is a registered trade-mark of Bank of Montreal.

This communication is intended for informational purposes only. This update represents the assessment of the markets at the time of publication. Those views are subject to change without notice as markets change over time. The information contained herein is not, and should not be construed as, investment advice to any party. Particular investments or trading strategies should be evaluated relative to each individual’s investment objectives. Professional advice should be obtained with respect to any circumstance.

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