Financial Favorite: The Right Price

07/22/2015 9:00 am EST

Focus: FUNDS

Mark Salzinger

Editor and Publisher, The No-Load Fund Investor

The financial services sector has outperformed the broader market over the past three years, after lagging the market dramatically from 2008 through 2011 during and in the immediate aftermath of the credit crisis, explains Mark Salzinger, editor of The No-Load Fund Investor.

The improvement in the US economy continues to bolster financials, including banks, insurers, and brokerages.

Meanwhile, potential increases in interest rates could improve many financials’ prospects even further, since lenders would receive higher levels of interest while insurers could invest their premium income in higher-yielding securities.

Price Financial Services (PRISX) is our favorite actively managed financial services stock fund. Under a series of managers over the past ten years, the fund has regularly bested its average peer, outperforming on an absolute basis while exposing investors to comparable volatility.

Current manager Gabriel Solomon took over day-to-day responsibilities in April 2014. On his watch, the fund’s total return has been 19.5% (through June 30, 2015), vs. 12.0% for the S&P 500 and 9.9% for the average financial services fund.

Like most portfolio managers at Price, Solomon emphasizes the primacy of individual stock selection. He is supported by six US-based financial sector analysts, as well as other analysts in Price’s offices around the world.

Prior to taking over as manager of the fund, Solomon himself had been an analyst at Price for a decade.

He describes his approach to valuation as “unorthodox.” He prefers to focus on fundamental factors that other investors have misjudged.

He cites—as an example—investors’ disdain for three of the largest US banks and holdings in the fund: Citigroup (C), JPMorgan Chase (JPM) and Bank of America (BAC).

Each has a P/E on estimated earnings of only about 10. Solomon believes that the regulatory bad news about these companies already has passed and is discounted in their share prices.

Meanwhile, the portfolio’s holdings of several attractive regional banks are appealing to Solomon because they are potential merger or acquisition targets.

Banks recently accounted for 40% of the fund, followed by capital
markets (including brokers and investment managers), and insurance.

Solomon says the long-term prospects for many REITs are not compelling, and their limited presence in the portfolio has helped the fund’s performance in 2015, as most REITs have dropped in price this year.

Price Financial Services can have up to 20% of its portfolio in foreign stocks but recently had only about 7%.

Solomon says the proportion of foreign stocks is not a macroeconomic call about the attractiveness of foreign markets or economies, but rather, a byproduct of individual stock selection.

Despite good performance in recent years, valuations within the financial services sector are generally still not high.

For example, of Vanguard’s 11 sector exchange traded funds (ETFs), the one for financial services stocks has the lowest price/earnings ratio, despite good prospects for earnings growth.

Therefore, the sector represents a good opportunity for capital appreciation from current levels.

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