Perhaps unbeknown to many investors, particularly those new to the game, financial services is the second-largest sector allocation in the S&P 500 behind only technology.
Still, financials don’t even command half the weight of tech in the benchmark domestic equity gauge. Year-to-date, the Financial Select Sector SPDR (NYSE: XLF) is up 8. 8%, representing a solid though middling performance among the Sector SPDR exchange traded funds. Throw in the sector’s status a prime value haven and it’s understandable why some investors are glossing over it in favor of more glamorous fare.
Now isn’t the time to ignore the financial services sector. Not after the largest banks passed the Federal Reserve’s recent stress test with flying colors – news that was accompanied by a spate of headlines pertaining to significantly increased buybacks and dividends. So yes, the not-so-awe-inspiring distribution yield of 1. 37% sported by XLF is poised to tick higher in the months ahead because third-quarter bank dividends are poised to increase.
“Large banks remain well capitalized and resilient to a range of severe outcomes,” Federal Reserve Vice Chair for Supervision Michelle W. Bowman said in a press release.
More Factors Favoring Financials
Advisors know this, but many younger clients and investors may not: prior to the global financial crisis, financial services was one of the most reliable sectors for dividend growth. So the earnest return of shareholder rewards in the sector – something that’s taken years to arrive – is positive on a standalone basis.
However, bigger buybacks and dividends aren’t the only reasons to consider the sector. The sector has multiple tailwinds beyond shareholder rewards, including evidence that capital markets activity is showing signs of life.
“Banks, asset management firms, companies and investors are finally seeing capital markets activity begin to thaw, after months of hesitation driven by uncertainty around U. S. tariff policies and market volatility,” notes Morgan Stanley. “While most financial sponsors and corporates adopted a wait-and-see approach on mergers and acquisitions and initial public offerings in the first quarter of 2025, windows of opportunity are beginning to open, especially for companies with limited exposure to supply-chain disruptions. ”
That’s not conjecture or an investment bank “talking its book. ” There’s clear and compelling evidence capital markets vibrancy, including some recent ballyhooed initial public offerings (IPOs).
“On the IPO front, companies with business models that are relatively insulated from trade and supply-chain disruptions are finding windows to go public,” adds Morgan Stanley. “But for other corporates, the macroeconomic uncertainty has made it difficult to offer a three-to-four-year earnings forecast and therefore challenging for investors to value companies. Some executives at the conference said that sponsor-backed companies may opt for M&A instead of IPOs as an exit route, because of these challenges. ”
Private Assets Another Sparks for Financial Services Sector
What financial services lacks in glitz and glamor relative to tech it makes up for with inventiveness. Recently, that trend has grown to include prescient packaging of private assets, thus expanding the field of potential investors.
Those market participants are responding with an overt thirst of private credit assets – demand that could be a long-ranging catalyst for the sector.
“Private credit continues to attract strong demand from institutional investors, and banks and asset managers at the conference cited it as one of the biggest opportunities for growth. The size of the private credit market at the start of 2024 was approximately $1. 5 trillion, compared to approximately $1 trillion in 2020, and it is estimated to grow to $2. 8 trillion by 2028,” concludes Morgan Stanley.
