Many of the big banks have reported or are announcing fourth-quarter earnings this week, including Bank of America (NYSE:BAC) on Thursday. Analysts expect it to make money on a 7% increase in revenue. Option traders have become very bullish about its prospects, with the ratio of call options double the number of sell options — the highest spread in a decade.
But with banks still on shaky ground, those interested in making an investment in Bank of America should instead consider opting for an exchange-traded fund. Here’s why:
If you believe the phrase “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 (NYSE: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 to 54.3% for the S&P 500. A simple bet on a rising tide that turned out beautifully. The same principle applies with banking.
A total of nine ETFs have Bank of America in its top 10 holdings. Narrowing down 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 (NYSE: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 (NYSE:BRK.B) at 9.55%. With a total of 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 (NYSE: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 currently represents 6.56% of the portfolio, with JPMorgan Chase (NYSE: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 to 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, big is better. If you’re of this mind-set, your best bet is the Financial Select Sector SPDR (NYSE:XLF), which has assets under management of $6.2 billion. The fund itself has 81 holdings and is similarly constituted to RWW, the only difference being 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 (NYSE: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.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.