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Superman's back in theatres with a few lessons for us mortals—and perhaps a thing or two for investors. It turns out the man of steel has a lot in common with bank stocks. Both show their incredible strength in times of turmoil and both have one single, seemingly harmless thing that can render them weaklings. With Superman that one thing is Kryptonite—with bank stocks it's interest rates.
Bank, or financial services stocks are considered interest-rate-sensitive stocks. That's not to say financial services stocks go up or down with increases and decreases in interest rates. These days banks are both heavy borrowers and heavy lenders—and that makes them sensitive to mere changes in interest rates.
Financial services stocks—especially Canadian financial services stocks—have been among the top performing sectors in the post-911 equity market dues in large part to strong, consistent earnings. Over the past three years the average financial services mutual fund has returned 13.3 per cent annually, while the benchmark Globe Financial Services Peer Index has returned over 14 per cent. Over the same period the S&P/TSX Canadian Financials Index has risen over twenty per cent annually.
Over the same three year period interest rates hit their lowest levels in forty years. Recently central banks, including the Bank of Canada and the U.S. Federal Reserve have been raising their benchmark rates from those lows to help keep inflation in check. When rates rise, borrowing becomes more expensive, spending slows, and inflation cools.
Now that interest rates are at, or very near, the top of the current cycle it appears the evolution of the financial services industry has rendered its own form of kryptonite useless. Derek Holt, assistant chief economist with RBC Financial Group says banks have managed to insulate themselves from fluctuating interest rates. "The industry has changed so much because banking offers more diversified services" he says. "There are no more easy rules of thumb".
Mr. Holt attributes the changes to a 1987 federal government decision to allow banks to merge their retail banking services with their brokerage services, and later a 1992 decision to allow estate planning services to merge with wealth management services. He says U.S. banks are slow to follow the trend but they are well on the diversification bandwagon. As a result RBC Financial Group considers financial services stocks "generally good to neutral".
Ten mutual companies offer open-ended financial services mutual funds on the Canadian market. The top performer over the past three years is the U.S. denominated AGF Global Financial Services fund with an average annual return of 26.7 per cent. As the name implies, the fund holds global bank stocks—mostly in the United States and Europe.
No single Canadian Financial Services fund manager has been able to beat the Canadian benchmark index over the past three years. The best performing Canadian bank fund is an index fund sponsored by Barclays Global Investors Canada Ltd that tracks the S&P/TSX Canadian Financials Index. The iShares Canadian Financial Sector Index fund has returned and average 20.6 per cent annually over the past three years.
The only managed bank fund with a majority of Canadian equities to come close to the benchmark index over the past three years is Dynamic FocusPlusWealth Management with an average annual return of 19.3 per cent. That performance difference can be partly attributed to the 2.87 per cent management expense ratio for the Dynamic fund versus a 0.55 per cent MER for the Barclays fund.
Financial services mutual funds are fairly new to the Canadian market. No single fund has a longer track record than five years and the average annual five-year return is 4.3 per cent. The next phase of the interest rate cycle will be a test to see if the big banks can bounce interest rate bullets off their chests.
Dale Jackson has been a producer at Report on Business Television since its launch in September 1999.