PFI: PowerShares Dynamic Financials Outperforms Its Peers
Don Dion
Don's Investment Newsletter: Don's Asset Management Business:
After a mixed round of earnings this summer and ongoing uncertainty about valuation, the financial sector remains plagued with enough speculation to keep many investors on the sideline. As more financial institutions are added to the “probation list” of U.S. regulators, investors have become more divided over whether financial stocks have bottomed or whether the worst is yet to come.
While financial ETFs have suffered the same pullback as their financial components, some have fared better than others in the onslaught of bad news. Among the ETFs covered by PowerShares Momentum Tracker, PowerShares Dynamic Financials (PFI) has led the pack, showing remarkable resilience in a difficult environment. Since July 17, PFI has jumped 10 spots on the Sector Momentum Table, moving from the 48th to 38th position. According to Morningstar, PFI’s three-month return has also outperformed the sector, besting the S&P 500 by 3.02%.
PFI tracks the Dynamic Financial Intellidex Index, which selects components based on a wide range of criteria from fundamental growth and stock valuation to investments and risk factors. PFI’s methodology seeks to select securities with the greatest capital appreciation potential for incorporation into the index. While these criteria are fairly standard fare for a broad index—factors such as weighting, market cap and style allocations have helped PFI to weather the financial storm.
PFI’s formula has placed the overwhelming majority of included equities under the classification of “value.” Rather than concentrating allocation into solely large-cap financials, PFI diversifies evenly across the sector, with 26.42% in large-cap value, 26.35% in mid-cap value and 29.70% in small-cap value—a feature that emphasizes a “best of breed” strategy. This allocation has undoubtedly lessened the blow from the largest financials in recent months, cushioning PFI from the brunt of the market downturn while other large-cap value financial ETFs—such as iShares’ Dow Finance (IYF)—have sustained greater losses. As of August 21, PFI was down only 11.78% year to date while IYF had fallen more than 25% in the same period.
Another attribute of PFI that has helped to cut market risk is a low concentration in the fund’s top holdings. While PFI does not contain a particularly large number of stocks—60 in total—the fund’s allocation is spread fairly evenly throughout the index. PFI’s top holding, TD Ameritrade, constitutes only 2.91% of the index—the top 10 holdings compose only 25.38% of the fund as of August 25. When you compare this to IYF’s 36.26% concentration in its top components, PFI’s composition may offer a safer alternative for investors looking for a more conservative allocation.
PFI’s top two holdings, TD Ameritrade (AMTD) and Northern Trust Corp. (NTRS), have both held up well in a difficult environment. TD Ameritrade reported in July that the number of trades executed had increased from 2007 and risen 9% since June. As other financial institutions unveiled increasing debt, TD Ameritrade’s 29% jump in profits helped to boost PFI’s NAV. Similarly, Northern Trust recently announced that it would be offering new features to attract institutional orders—including a fundamental “dashboard” to help investors evaluate equities. As market share continues to move from brokerage houses and major exchanges, PFI’s top holdings may benefit from an increased “do-it-yourself” attitude among investors.
PFI’s structure and allocations, however, are not without investor risk. Despite the fund’s sector performance, volume in PFI has been light. With a three-month average of 13,000 shares traded daily, PFI is dwarfed by the liquidity of larger financial ETFs such as IYF, which has traded an average of 8 million shares a day for the same period.
It is also important for potential investors to examine the potential downside of PFI’s silver lining—while the range of PFI’s components have lessened blows to NAV delivered by large banks, PFI might not gain momentum as quickly as some of its larger competitors if the Dow spikes upward.
As uncertainty within the financial sector continues to rise, PFI’s relative performance may not assuage investors who believe that the worst is yet to come. For those who are brave enough to tiptoe into the conservative end of the financial tide pool, however, PFI’s fundamental methodology and returns may help this ETF to stand out from a hard-hit sector. Regardless of which camp you fall into, PFI’s contrast to its peers offers a compelling reason to watch its index during the final stretch of 2008.
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