Six Ways to Short Financial Stocks with ETFs

The global economic slowdown and lower energy prices haven’t spared any corner of the U.S. equity market. It’s most recent victim is the financial sector. In fact, the ultra-popular Financial Select Sector SPDR Fund (XLF) is one of the worst performing ETFs of this year, having shed 12.4% so far compared with a loss of 5.7% suffered by the broad market fund (SPY).  

What Happened?

The sell-off in the sector intensified when Bank of Japan adopted a negative interest rates policy and European Central Bank hinted at additional stimulus in its March meeting. In addition, the likelihood of the next interest rates hike anytime soon in the U.S. has also faded due to instability in the financial stock market and weak global fundamentals.

As a result, the yield curve is flattening with Treasury yields on a decline. The gap between tthree-month deposit rates and 10-year lending rates was the narrowest since August 2012 in the U.S. and is approaching the early 2015 lows in the Eurozone, indicating that bank net interest margins will be stressed ahead. These have raised worries over the health of the banks and increased chances of default. Additionally, negative or lower interest rates will discourage investors to deposit their money in banks as this could eat away some fraction of their money initially, leaving them with less than what they had invested.

Further, the banks, which are highly exposed to the energy sector, are increasing their loan reserves due to a prolonged decline in crude oil prices. The higher provisioning to cover the bad loans of the energy companies are weighing on their overall earnings picture and could result in deteriorating credit quality. The situation could worsen over the coming months if oil price falls further or remains at low levels (read: Forget Production Cut: Short Oil & Energy ETFs).

Moreover, XLF, with an asset base of around $15.3 billion and average daily volume of around 51.6 million shares, pulled out $1.6 billion from its asset base so far this year, according to data compiled by etf.com.

Given the massive outflow and the bearish outlook, the appeal for financial ETFs, especially the banks, is dulling. As a result, investors who are bearish on the sector right now may want to consider a near-term short. Fortunately, with the advent of ETFs, this is quite easy as there are many options to accomplish this task. Below we highlight them and state how each stands out among the rest.

ProShares Short Financials ETF (SEF)

This fund provides unleveraged inverse (or opposite) exposure to the daily performance of the Dow Jones U.S. Financials Index. The ETF makes a profit when the financial stocks decline and is suitable for hedging purposes against the fall of these stocks. The product has amassed $40.6 million in AUM while volume is light around 41,000 shares. Expense ratio came in at 0.95%. The product has added over 12% in the year-to-date timeframe.

ProShares UltraShort Financials ETF (SKF)

This fund seeks two times (2x) leveraged inverse exposure to the Dow Jones U.S. Financials Index, charging 95 bps in fees. It has amassed $71.9 million in its asset base and trades in a moderate volume of around 57,000 shares per day on average. SKF has returned about 24% so far this year.

ProShares UltraPro Short Financial Select Sector ETF (FINZ)

Investors having a more bearish view and a higher risk appetite may find FINZ interesting as the fund provides three times (3x) inverse exposure to the S&P Financial Select Sector Index. It charges 95 bps per year while the average daily trading volume is paltry at just 5,000 shares. It has amassed $2.3 million in AUM and surged 39.4% in the year-to-date timeframe.

Direxion Daily Financial Bear 3x Shares ETF (FAZ)

This product also provides three times inverse exposure to the Russell 1000 Financial Services Index. Though it charges the same annual fee of 95 bps, it is extremely popular with AUM of $378.7 million and trades in heavy volume of more than 1.3 million shares. The fund has gained 33.8% in the same timeframe (read: 16 Highly Traded Leveraged/Inverse ETFs of 2016).

ProShares Short S&P Regional Banking ETF (KRS)

This fund provides unleveraged inverse exposure to the daily performance of the S&P Regional Banks Select Industry Index. It is an unpopular and illiquid choice in the space with AUM of just $1.4 million and average daily volume of under 2,000 shares. Expense ratio comes in at 0.95%. The fund has added 20.9% so far this year.