Tuck Bank of America into a financial ETF
But make sure you avoid bank-only funds.
Many big banks have reported, or are announcing, fourth-quarter earnings this week, including Bank of America (BAC), which announced a positive earnings surprise Thursday.
But with banks still on shaky ground, investors interested in Bank of America should instead consider opting for an exchange-traded fund.
If you believe a rising tide lifts all boats, then an investment in BAC at the expense of every other financial stock seems irrational. Since there is no way of knowing whether it will outperform its peers in the months and years to come, the sensible investment is to bet on a group of banks and/or financial companies rather than Bank of America itself.
Back in April 2009, I recommended investors bet on a retail recovery, as all the signs pointed to one. However, instead of trying to pick one or two winners, I suggested the easiest approach was to buy an ETF invested in a basket of retail stocks. For instance, if you'd bought the PowerShares Dynamic Retail Portfolio (PMR) -- a portfolio of 30 top U.S. retailers -- in April 2009, you'd have a total return of 70.7% as of Jan. 13, compared with 54.3% for the S&P 500. A simple bet on a rising tide that turned out beautifully. The same principle applies with banking.
Nine ETFs have Bank of America in their top 10 holdings. Narrowing the choice is a matter of personal preference. If you really had your heart set on an investment in BAC stock, RevenueShares Financials Sector Fund (RWW) -- an ETF based on revenue instead of market capitalization -- has the highest weighting of the nine funds at 9.42%, its second-largest holding behind Berkshire Hathaway (BRK.B) at 9.55%. With 81 holdings, the fund invests in banks, insurance companies and even real-estate investment trusts. In the past three years, it has outperformed the financial sector by 238 basis points annually, although it was down a hefty 24% in 2011.
If you are more interested in the banks themselves and not so much the insurance and brokerage businesses, your best bet is the PowerShares KBW Bank Portfolio (KBWB), a 24-stock portfolio that tracks the KBW Bank Index, which invests in national money center banks and leading regional banks or thrifts. Bank of America represents 6.56% of the portfolio, with JPMorgan Chase (JPM) No. 1 at 7.9%. Because its inception was Nov. 1, 2011, its assets under management are just $87.7 million, and it has no track record. However, the bank index itself has a three-year annual return of -2.36%, compared with 2.92% for the S&P 500 Financials index. I'd also probably want a bit more diversification, but that's just me.
For some people, bigger is better. If you're of that mind-set, your best bet is the Financial Select Sector SPDR (XLF), which has assets of $6.2 billion. The fund has 81 holdings and is similarly constituted to RWW, the only difference being that this fund is market-cap-weighted as opposed to revenue-weighted. As a result, Bank of America's weighting in this portfolio is just 3.68%, or 574 basis points less, while Wells Fargo (WFC) is 198 basis points higher at 9.49%.
In terms of performance, the RevenueShares fund outperformed the XLF by 167 basis points annually over a three-year period -- an indication that capitalization-weighted indices aren't all they're cracked up to be.
Unless you firmly believe that banks are going to be the winners in the financial sector in the coming months and years, the RevenueShares Financials Sector Fund and the Financial Select Sector SPDR provide better diversification than a bank-only fund.
You can find the best ETFs for all of 2012 here.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.
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