The financial sector was badly hit in the credit crunch and global economic crisis which followed it. As a result, it has fewer constituents and accounts for less of the total value of the UK stock market than it did a decade ago.
In the banking sector, several smaller companies have emerged to challenge the established high street names.
What’s included in this sector?: Although it might seem quite impenetrable and complex the sector actually includes companies which you deal with on a day to day basis and could include the provider of your mortgage, bank or savings account, the company which insures your car, the firm which manages your pension and, if you invest, your stockbroker.
The industry: Banks, which make up nearly half the sector, are a vital component of a vibrant economy and the financial system would collapse without them.
Risk profile: Once seen as steady investments there has been a significant transition in the last 10 years, with several institutions collapsing or being swallowed up with increased regulation a material risk for financial institutions.
The objectives you might have for investing in this sector: Previously reliable income stocks like Royal Bank of Scotland (RBS) and Lloyds (LLOY) are now recovery plays.
The likes of banking giant HSBC (HSBA) and insurance firm Prudential (PRU) arguably enjoy greater growth potential as they target emerging markets which are seeing a growing middle class with increased demand for financial services.
Having returned to the dividend list, investors will be hoping Lloyds can reclaim its status as a reliable dividend stock.
Higher profile companies in this sector:
HSBC (HSBA) - Europe's largest banking group with significant exposure to emerging markets and Asia in particular
Lloyds Banking Group (LLOY) - Back in private ownership after years of state support. Focused on the UK.
Prudential (PRU) - Strong Asian footprint and benefits from demographic trends which drive demand for savings products.
Affected by:
Interest rates
Exchange rates
Demographics
A buoyant economy is good news for banks but the big things to watch are interest rates, which affect both their own cost of borrowing and what they charge their consumers, and exchange rates.
As interest rates go up so does the risk of bad debts (i.e. ones which cannot be repaid). While an ageing population could increase demand for savings and pension products provided by the life insurance industry.
Affects:
Property and housebuilding
Consumers
GDP growth
Willingness to lend on the part of the banks has a direct impact on consumers and the property market as well as the wider business community. For an economy to grow it needs strong, well-capitalised banks.
Numbers to watch out for:
Loan-to-deposit ratio - a bank’s total loans divided by its total deposits
Core tier 1 ratio- a measure of how much capital a bank has to absorb losses
Combined ratio - A ratio above 100% means an insurance company is paying out more in claims than it receives in premiums - anything below implies the opposite
Global insurance claims - The amount of people claiming on their insurance policies worldwide
Assets under management - The market value of assets that an investment company manages on behalf of investors
Relevant ETFs:
Lyxor MSCI World Financials (FING) - tracks a basket of global financial institutions
db X-trackers Stoxx Europe 600 Banks (XS7R) - offers exposure to the European banking sector
iShares S&P 500 Financials Sector (UIFS) - invests directly to achieve the performance of financially-focused stocks in the US
