An Easy Way to Focus on Stronger Financial Stocks

Exchange-traded funds offer a convenient way to invest in sectors or niches that interest you. If you expect the financial sector to do well over time as it recovers from the meltdown of several years ago, the First Trust Financials AlphaDex ETF (NYSE: FXO  ) could save you a lot of trouble. Instead of trying to figure out which companies will perform best, you can use this ETF to invest in lots of them simultaneously. It's based on an "enhanced" index that eliminates from the Russell 1000 the financial stocks with low growth and value characteristics relative to their peers.

The basics
ETFs often sport lower expense ratios than their mutual-fund cousins. The First Trust ETF's expense ratio -- its annual fee -- is a relatively low 0.7%. The fund is fairly small, too, so if you're thinking of buying, beware of occasionally large spreads between its bid and ask prices. Consider using a limit order if you want to buy in.

This ETF has performed reasonably well, beating the world market over the past three years and slightly beating it over the past five. As with most investments, of course, we can't expect outstanding performances in every quarter or year. Investors with conviction need to wait for their holdings to deliver.

What's in it?
More than a handful of financial companies had strong performances over the past year. Private-equity and venture capital specialist American Capital  (Nasdaq: ACAS  ) gained 81%. The company has been busy selling off some businesses, buying back shares, and paying down debt. Bulls are looking forward to the company reinstating its dividend in the near future, as management has said it would like to do, but my colleague John Maxfield warns that the company may be too inscrutable for most investors.

MetLife (NYSE: MET  ) gained 25%, despite some flagging domestic interest in life insurance. The company aims to combat that by, among other things, focusing more heavily on fast-growing emerging markets and shedding less-productive businesses. It recently announced a new asset-management business, for example, and is offering prepaid life insurance packages through a partnership with Wal-Mart (NYSE: WMT  ) .

Mortgage REIT Chimera Investment (NYSE: CIM  ) advanced 19% and recently offered a hefty 13% dividend yield. It invests in riskier loans than peers such as Annaly Capital Management (NYSE: NLY  ) and offsets that risk by employing less debt. It has worried some investors, though, by not filing financial statements on time. Meanwhile, changes in interest rates threaten the profitability of mREITs, and dividend cuts are a possibility.

Other companies didn't do as well last year but could see their fortunes change in years to come. Leucadia National (NYSE: LUK  ) , for example, was essentially flat. The diversified holding company typically provides financial support to companies in exchange for a stake in their business. Its management is held in very high regard, the company is involved in businesses ranging from investment banking to beef, and it's poised to profit from a rebound in housing as well.

The big picture
Demand for financial services isn't going away anytime soon. A well-chosen ETF can grant you instant diversification across any industry or group of companies and make investing in it -- and profiting from it -- that much easier.

If you're intrigued by mortgage REITs such as Chimera, check out our premium report on Annaly, another mREIT, and learn more about the potential of the business. Click here today and lock in a year's worth of free updates, as well.

Longtime Fool contributor Selena Maranjian owns shares of Annaly Capital Management and Walmart. The Motley Fool owns shares of Annaly Capital Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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  • Report this Comment On October 15, 2012, at 11:25 AM, NotMyBusinessBut wrote:

    >> but my colleague John Maxfield warns that the company may be too inscrutable for most investors.

    Selena,

    It is very unfortunate that you have chosen to reference Mr. Maxfield's "analysis" (and I'm being VERY kind).

    If you read the comments you will see that he has been thoroughly discredited in his comments.

    I know the game on MF is to be incestuous so that you can drive each other's clicks .. but to reference Mr. Maxwell's article does disservice to your readers and only tends to discredit you.

    NMB

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