Financials have been on a tear since the beginning of this year, gaining significantly on optimism surrounding a higher rate environment and strong economic expansion and steady job growth. At the end of its policy meeting held on Dec 12-13, the Fed decided to increase its key rate for the third time this year and signaled three more hikes in 2018.

With the fifth rise in Fed interest rate since the 2008 financial crisis, prospects for the financial sector have improved. Given this backdrop, mutual funds with significant exposure to the financial sector are expected to be strong investments as key interest rate is likely to march higher in the near future.

Unemployment Still At 17-Year Low, Q3 GDP Advances

In its second estimate, GDP increased from the previous estimate of 3% to 3.3%, the best since the third quarter of 2014. It also improved from the second quarter’s pace of 3.1%. Moreover, corporate profits after tax increased 5.8% year over year, after a 0.1% uptick in the second quarter of this year. Additionally, both consumer spending and business investment gained traction in the third quarter. 

More significantly, domestic non-farm payrolls advanced by 228,000 in November, significantly higher than the consensus estimate of 199,000, per the U.S. Bureau of Labor Statistics. Additionally, the unemployment rate remained unchanged at 4.1% in November, its lowest in 17 years.

Fed Hikes Rate For 3rd Time in 2017

Following its two-day Federal Open Market Committee (FOMC) policy meeting held on Dec 13-14, the Federal Reserve decided to raise its key interest rate by 25 basis points. The central bank raised its key rate for the third time this year and for the fifth time in almost a decade. Moreover, the Fed also expects three additional rate hikes next year and two more in 2019.

The central bank projects economic growth at the rate of 2.5% in 2018, up from the previous expectation of 2.1%. Further, the growth rate is anticipated to be 2.1% in 2019 — moderately higher than the previous forecast of 2%.

How Does a Rate Hike Benefit Financials?

High rate environment bodes well for financial companies including banks, money managers, insurance firms and brokerage companies. Banks derive benefits from a steep yield curve, i.e. when the spread between long-term and short-term rates widens. This means that the potential rise in rates will enable banks to charge more for loans, leading to an increase in the spread between lending rates and the rates paid on deposits.

Also, rising rates reflect an improving domestic economy. Higher economic growth attracts more investment, which in turn is expected to benefit brokerage firms and money managers. For insurance companies, high rate environment ensures that their underlying bond investments provide strong returns. 

Buy These 5 Financial Mutual Funds

The financial sector performed favorably in recent times following the Fed’s interest rate hikes and Trump’s proposed economic policies. Market watchers believe that this rally will continue if rates march higher even in 2018. Financial Select Sector SPDR (XLF) has advanced 19.1% so far this year. According to Morningstar, the financial mutual fund category has posted year-to-date (YTD) and one-year returns of 15.2% and 15.7%, respectively.

This encouraging backdrop warrants investor focus on five financial mutual funds that boast a Zacks Mutual Fund Rank #1 (Strong Buy) or 2 (Buy). Moreover, these funds have impressive year-to-date (YTD) returns. They also have minimum initial investment within $5000 and low expense ratios.

We expect these funds to outperform their 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 also on the likely future success of the fund.

Fidelity Select Banking (FSRBX - Free Report) seeks appreciation of capital. FSRBX normally invests at least 80% of assets in common stocks of companies principally involved in banking. The fund invests in both U.S. and non-U.S. companies.

FSRBX has YTD returns of 11.7% and an expense ratio of 0.79% compared with the category average of 1.60%. The fund has a Zacks Mutual Fund Rank #2.

JHancock Financial Industries A (FIDAX - Free Report) seeks growth of capital. FIDAX invests the majority of its assets in equity securities of domestic and foreign financial companies. The fund may also invest around 5% of its assets in U.S. and non-U.S. bonds, which are rated below investment grade.

The fund has YTD returns of 12.7% and an expense ratio of 1.25% compared with the category average of 1.60%. FIDAX has a Zacks Mutual Fund Rank #2.

Prudential Jennison Financial Services A (PFSAX - Free Report) seeks capital growth for the long run. PFSAX invests a heavy portion of its assets in equity securities of asset management companies, securities/brokerage firms, mortgage banking companies, banks, insurance companies, industrial finance companies and leasing companies.

PFSAX has YTD returns of 22.3% and an expense ratio of 1.42% compared with the category average of 1.60%. The fund has a Zacks Mutual Fund Rank #2.

Fidelity Select Financial Services Portfolio (FIDSX - Free Report) invests the majority of its assets in common stocks of companies involved in offering financial services to industry and consumers. FIDSX seeks capital growth for the long run. Before investing in financial companies, the fund measures their industry position and financial condition.

The fund has YTD returns of 19.8% and an expense ratio of 0.76% compared with the category average of 1.60%. FIDSX has a Zacks Mutual Fund Rank #1.

Fidelity Select Consumer Finance Portfolio (FSVLX - Free Report) seeks appreciation of capital. FSVLX invests more than 80% of its assets in equity securities of companies involved in offering services related to consumer finance. The fund considers financial strength and economic conditions before investing in a company.

FSVLX has YTD returns of 21.2% and an expense ratio of 0.93% compared with the category average of 1.60%. The fund has a Zacks Mutual Fund Rank #2.