While rising rates tend to push up corporate borrowing costs and make fixed income investments more attractive relative to equity, there is one sector that benefits from rising rates: financial, observes Vaughan Scully of S&P Capital IQ.
Banks like rising interest rates, because it helps widen their net interest margin, or the difference between their borrowing costs and their interest income.
Insurance companies also like higher rates because that means a higher yield on their investments, one of their most important sources of income.
S&P Capital IQ recently upgraded its recommendation on the financials sector of the S&P 500 (SPX) to “overweight” from “marketweight,” citing stronger domestic and international economic growth, as well as a steepening yield curve, faster loan growth, and improving credit quality.
To uncover attractive mutual funds in the domestic financials sector, we used the MarketScope Advisor screening tool to sort out US domestic equity funds within the financial services peer group that have our highest five-star ranking.
We excluded institutional funds, those that are closed to new investors, and those that charge a front end sales load. Three funds made the cut.
Emerald Banking and Finance Fund (US:HSSAX)
This fund, one of just two managed by Leola, Pennsylvania-based Emerald Mutual Funds, invests primarily in community banks, real estate investment trusts, and insurance companies.
As of September 30, 2013, it had 116 individual holdings in a relatively diversified portfolio: its largest holding, Bank of the Ozarks (OZRK) accounted for just 3.8% of assets, with its top ten holdings representing less than 25%.
It owns mostly smaller companies, with the average market capitalization of its holdings just $1.14 billion, compared with about $40 billion for its peer group.
Fidelity Select Consumer Finance (US:FSVLX)
This fund owns shares of companies that issue credit cards and provide other types of financial services to consumers. S&P Capital IQ has a positive 12-month fundamental outlook for consumer finance companies, as the improving US economy lifts credit quality of borrowers.
Its portfolio is much more concentrated, with just 51 individual holdings, and the top ten accounting for about half of total assets. It also owns large companies, with the average market capitalization of its holdings about $51 billion, well above the peer average.
Fidelity Select Insurance Portfolio (US:FSPCX)
Life insurers have been coping with low rates for many years, and stand to benefit from any uptick. “A steady and measured rise in interest rates through 2014 and 2015 would do much to improve operating conditions for US life insurers,” say analysts at Standard & Poor's Ratings Services, which operates independently from S&P Capital IQ.
The most concentrated fund of the three, this fund has just 44 individual holdings, with the top ten accounting for about 59% of assets. It owns several large companies, though the average market capitalization of its holdings is just $27.2 billion, well below its peer average.
Subscribe to Standard & Poor's The Outlook here…
More from MoneyShow.com:
