The series of recently released earnings from finance companies has painted a disappointing picture of the sector. Several heavyweights have performed below expectations, hit by a slew of legal expenses. However, the worst seems to be over for financials and the long term prospects of this sector make it a prudent investment option.  

Outlook for the Finance Industry

Finance isn’t one monolithic group of companies; the constituent industries in the sector range from large money center banks to regional S&Ls, insurers, brokers and specialty finance operators like credit card issuers. The REITs – which pay the majority of their earnings as dividends – also get grouped in the finance sector.

The general outlook for the finance sector, one of the 16 broad Zacks sectors within the Zacks Industry classification, is optimistic on the whole. The consensus earnings year-over-year growth expectations for 2015 stand at 12.6% compared with the S&P 500 index (SPY) year-over-year growth rate of 3.9%.

Moreover, the year-over-year earnings growth rate for the first quarter of 2015 is predicted to be 9.3% compared with the S&P 500 index year-over-year negative growth rate of 0.1%. The first quarter of 2015 is anticipated to generate earnings of around $54.2 billion. Moving on to the margins, net margin is expected to be 16.1% in the first quarter of 2015, exhibiting a year-over-year improvement.

U.S. Economy Strengthens

Along with these encouraging estimates for the year, sustained GDP growth and reduction in unemployment will also assist in improving the operating environment. The IMF upgraded its U.S. growth rate estimate for 2015 to 3.6% from the previous forecast of 3.1% on the back of an indulgent monetary policy attitude, moderate fiscal adjustment, domestic demand supported by dropping oil prices, a steady decline in unemployment and reducing inflation pressure.

Meanwhile, the World Bank has said that the slump in oil prices has helped the U.S. economy because it has increased purchasing power of consumers. The World Bank sees US expanding at 3.2%, up from prior estimate of 3%.

Nevertheless, low labor force participation, potentially weaker net exports owing to appreciating dollar, sluggish growth in the housing sector and low interest rates exhibiting the chronic weakness of demand continue to pose a challenge for the U.S economy too. Moreover, the European Central Bank’s (ECB) plan to launch a $1 trillion bond-buying program will further strengthen the dollar, heightening the pressure on U.S. exports.

Can Finance Overcome Weak Earnings?
 

The immediate challenge for the sector is related to the slew of weak earnings reports. Most of these dismal results are due to legal expenses incurred on litigations dating back to pre-crisis times. Even though some of these remain unresolved, a large number of them have been dealt with, which means that the road ahead is significantly brighter.

Moreover, banks have shored up their reserves, taking into consideration these recent costs. Additionally, regulators have made it mandatory for such companies to maintain significant reserves. In this way, the situation has significantly improved, further brightening the sectors prospects.

Financial Mutual Funds

Mutual funds reduce risk to a significant extent because they offer the benefits of diversification. Additionally, low initial investment requirements and expense ratios add to the lucrativeness of this investment option.

Here we will list 3 financial mutual funds that carry 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.

These funds also have proven impressive performance, as they have minimum 14% return over 1-year period and minimum 15% returns over a 3-year period. The funds have relatively low expense ratio and carry no sales load. The maximum initial investment required is $2,500.

Fidelity Select Financial Services Portfolio (FIDSX - MF report) seeks capital growth. The fund invests a large share of its assets in securities of companies whose principal operations are related to offering financial services to retail and business customers. It focusses on acquiring on common stocks of both domestic and foreign companies.

FIDSX carries a Zacks Mutual Fund Rank #2 (Buy). The fund has a one-year return of 14.6% and three-year annualized return of 15.7%. It carries an expense ratio of 0.81% as compared to category average of 1.63%.

Schwab Financial Services (SWFFX - MF report) seeks capital appreciation over the long term. It invests heavily in equity securities of financial services companies. The fund concentrates on domestic issuers and invests without regard to the size of the company. It may invest all of its assets in cash, cash equivalents and repurchase agreements.

SWFFX carries a Zacks Mutual Fund Rank #1 (Strong Buy). The fund has a one-year return of 17.5% and three-year annualized return of 17.2%. It carries an expense ratio of 0.90% as compared to category average of 1.63%.

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 underlying value. It may invest all of its assets in foreign securities.

TEFAX carries a Zacks Mutual Fund Rank #2 (Buy). The fund has a one-year return of 14.1% and three-year annualized return of 15.3%. It carries an expense ratio of 1.16% as compared to category average of 1.63%.

About Zacks Mutual Fund Rank

By applying the Zacks Rank to mutual funds, investors can find funds that not only outpaced the market in the past but are also expected to outperform going forward.