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Financials Come in All Flavors

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Financial services stocks have bloomed under a benign climate of historically low interest rates the past few years. Now that the Federal Reserve is committed to raising rates, this asset class may come under pressure as earnings, margins, and credit quality contend with tightening credit.

Two of the better-performing financial services mutual funds over the past five years, the FBR Small-Cap Financial Fund (FBRSX) and the Forward Emerald Banking & Finance Fund (HSSAX), are small-cap portfolios that have a significant emphasis on community banks. However, one has a value orientation, while the other is a growth vehicle.

The $536-million FBR Small Cap Financial Fund focuses on companies with market caps under $3 billion, particularly the lesser-known community banks, thrifts, and savings and loans, which are largely ignored by Wall Street. Portfolio manager David Ellison, a disciple of famed value guru Peter Lynch, seeks stocks with the best earnings growth outlooks, but trading at the lowest price-to-earnings and price-to-book multiples. He’s more concerned with the execution of a company’s business model, rather than with changes in interest rates, credit conditions, and regulatory matters. As of June 30, the fund comprised 67 holdings, the top 10 of which represented 44.6% of total assets. Nearly 70% of the fund’s assets were invested in S&Ls. With a modest 36% turnover, the fund is designed for long-term investors.

Another top long-term performer, the $184-million Forward Emerald Banking & Finance Fund, invests primarily in small-cap banking and financial companies, but may also buy into such sectors as real estate investment trusts and technology. Managed by Ken Mertz, this growth portfolio typically holds between 90 and 95 stocks. As of June 30, top holdings included United Fire & Casualty Company (UFCC), a property and casualty insurance writer; commercial bank MB Financial Inc. (MBFI); and Texas-based bank Prosperity Bancshares Inc. (PRSP).–Palash R. Ghosh


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