Banking on banking ETFs

Global banks and brokerages, vilified for their role in the global financial crisis and later price-rigging scandals, are back in fashion with investors.

That may seem surprising since banks continue to spend billions on U.S. legal settlements years after the housing market meltdown and financial failures of 2008 and 2009.

In the U.S., banks also face a much tougher post-crisis regulatory environment and higher costs, thanks to the Dodd-Frank reforms and the Consumer Protection Act.

Banks outperform

And yet, the KBW Bank Index, representing national money center banks and leading regional institutions, is up 6.7% this year through July 27, compared with a 1% rise for the S&P 500 Index. The bank index has advanced 11% over the last 12 months.

Billionaire investor Warren Buffett has liked the outlook for banks since early in 2015. Berkshire Hathaway (BRK.A) disclosed in a recent regulatory filing in March that it has added significantly to its holdings of Wells Fargo (WFC) and US Bancorp (USB).

Robust earnings

In the most recent quarter, Citigroup (C) posted its best results in eight years as a restructuring drive delivered returns, Bank of America's (BAC) earnings more than doubled and J.P. Morgan (JPM) and Morgan Stanley (MS) beat expectations.

For all of 2015, analysts surveyed by FactSet Research are forecasting a 16% jump in profits by financial-related companies that trade on the S&P 500 Index.

Covestor portfolio manager and Timberline Investment Management founder Gregg Giboney says that while the sector still has image problems, banks are starting to look like an attractive investment again.

Fed tailwinds

While a higher level of regulation may make bank stocks less attractive in some respects, financial stocks now "are quite attractive relative to the overall market" on price-to-earnings and price-to-book measures, according to Giboney.

Bank profits may also get a boost should the US Federal Reserve boost interest rates later in the year as expected. Higher short-term rates will boost bank net interest margins that have been getting squeezed by historically low rates.

"Future earnings may not be as robust as in the past," says Giboney, "but as long as the economy grows, banks will have opportunities to build loans, non-fee business and earnings at an attractive pace."

Investors looking for ETFs that track the financial sector have an array of options to choose from such as the iShares US Financial Services (IYG), Financial Select Sector SPDR (XLF) and Vanguard Financial (VHF) funds.

Not all global banks have fully put their legal troubles behind them. Goldman Sachs (GS) is reportedly in talks to pay $2 billion to $3 billion to settle a probe into its sales of mortgage bonds leading up to the financial crisis. The investment bank's second quarter results were dragged down in part by a surge in litigation expenses.

Yet as the financial impact of the global credit crisis recede, the outlook for major US banks is starting to improve. Some big banks aren't out of the penalty box just yet. However, investors are looking forward and like what they see.

Sanjoy Ghosh is Chief Investment Officer at Covestor (Covestor.com), an online investing marketplace.