Rate Hike Now Or Later: Add These Funds To Your Portfolio

The general belief in recent times has been that the rate hike is sometime away. The recent batch of mixed economic data and the FOMC minutes were suggestive of a delayed hike. A certain section of market watchers have gone to the extent of saying that such a move won't happen until next year. However, the prolonged guessing game about the timing of a rate hike has now two comments from the Fed chair and other prominent officials that hint at a rate hike sooner than later.

It is somewhat tough to guess the exact timing of the first rate hike. The central bank is looking for improved economic pointers. However, as said, economic data has been mostly mixed. First quarter GDP was reported to have improved at a sluggish pace of 0.2%, significantly lower than the consensus estimate of a 1% gain. On the other hand, the consumer price index witnessed an encouraging gain.

Nonetheless, the rate hike will come sooner or later. In that case, it is advisable for investors to add funds that stand to gain from rate hikes and offload the ones that will have a negative impact. Financials are the front runners to gain from a rate hike. Investors should add them now before the positive effect is fully priced in.

Before we pick top-ranked funds from the Finance sector that investors should consider, let’s look at the recent comments that hinted at the possibility of a sooner rate hike.

Yellen Remains Optimistic

The Fed Chair Janet Yellen remains optimistic about the prospect of a rate hike this year. Speaking to the Chamber of Commerce in Providence, Rhode Island last Friday, Janet Yellen said she still expects the Fed to raise the benchmark rate this year.

Yellen believes the U.S. economy is well poised to grow despite soft economic data. She said: “If the economy continues to improve as I expect, I think it will be appropriate at some point this year to take the initial step to raise the federal-funds rate target and begin the process of normalizing monetary policy.” Yellen added that she needs to see further improvement in labor market conditions and to be “reasonably confident” that inflation moves closer to its target rate of 2%, before deciding on when to raise rates.

She said that government data may have overemphasized the effect of such conditions on the economy. This is why the Fed Chair believed a rate hike is still in the offing this year if the economy remains on course.

Fed Cleveland President Bullish on Hike

Fed Cleveland President Loretta Mester recently said if data was in line with her forecasts, a rate hike may not be far off. Mester said the FOMC will keep all its options open on such a decision ahead of its June meeting.

She added that the Fed will by that time be able to evaluate another report on the jobs market and other crucial data. Buoyancy in the labor market and acceleration in inflation mean that the benchmark rate is likely to be raised this year, followed by further monetary tightening, Mester added.

Why Financials Should Gain?

Financial firms, be it banks, brokerage houses, insurance companies or even money managers should be profitable bets. A rate hike should be indicative of a strengthening economy, which should mean that borrowers are better positioned to pay loan payments. Eventually, the banks’ non-performing assets should go down. Also, banks will earn more from the spread between what they get from highly-rated debt and what banks need to pay to clients for their savings.

Thus, the long-term rates should move up more than short-term rates. The interest rates on deposits are typically tied to short-term rates while loans are often tied to long-term rates. Banks benefit from a steep yield curve - the spread between long-term and short-term rates is wide.

For insurance companies, higher rates results in higher growth. Insurance companies take in premiums from customers, invest them - usually in fixed income securities - and then pay out claims in the future. Much of their profits are made on the interest income from their investments. Thus, higher rates will help them earn higher interest from investments. However on the downside, the value of existing bonds decline. Although insurers with a relatively short duration on their investment portfolios should be relatively immune.

For brokers, an improved economy would lead to more action on the investment front. Higher investment activity will boost their brokerage earnings. Also, brokerages earn interest income on un-invested cash in customer accounts. So when rates rise, they can invest this cash at higher rates.

3 Financial Funds to Buy Now

Here we will list 3 mutual funds from the Finance sector that carry either a Zacks Mutual Fund Rank #1 (Strong Buy) or Zacks Mutual Fund Rank #2 (Buy) as we expect the funds to outperform its peers in the future. Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but the likely future success of the fund.

They also have encouraging year-to-date and 3 and 5-year annualized returns and carry no sales load. The minimum initial investment for these funds is within $5000.

Franklin Mutual Financial Services Z (TEFAX - MF report) seeks capital growth with a secondary objective of income appreciation. The fund invests a lion’s share of its assets in financial services companies whose securities are attractively priced relative to their intrinsic value.

TEFAX currently carries a Zacks Mutual Fund Rank #1. While the year-to-date return stands at 8.5%, Franklin Mutual Financial Services Z has provided 3 and 5-year annualized returns of 20.4% and 13.3%. The annual expense ratio of 1.14% is lower than the category average of 1.55%.

Emerald Banking and Finance Investor (FFBFX - MF report) invests a lion’s share of its assets in companies primarily involved in the banking or financial services industries. FFBFX focuses on small to mid cap firms having market capitalization less than $1.5 billion.

FFBFX currently carries a Zacks Mutual Fund Rank #2. While the year-to-date return stands at 5%. Emerald Banking and Finance Investor has provided 3 and 5-year annualized returns of 22% and 14.1%. The annual expense ratio of 1.69% is however higher than the category average of 1.55%.

T. Rowe Price Financial Services (PRISX - MF report) invests at least 80% of net assets in the common stocks of companies in the financial services industry. The fund also invests in companies deriving substantial revenues from conducting business with the industry, such as providers of financial software.

PRISX currently carries a Zacks Mutual Fund Rank #2. While the year-to-date return stands at 5.2%. T. Rowe Price Financial Services has provided 3 and 5-year annualized returns of 23.4% and 13.3%. The annual expense ratio of 0.87% is lower than the category average of 1.55%.