Libor, Banks And Bank ETFs

I got on a plane the other day. As I was boarding, a guy came up in a wheelchair. He looked OK to me; however, the wheel chair took him straight to the plane. And it looked like he managed well enough as he got up and made his way to his seat. I didn’t see anything wrong, but one never knows. I try to be respectful of people who are not ambulatory.

We landed. It was a tight connection to the next flight. I got off the plane and really hoofed it to the next gate. The guy got off right behind me, and he was hoofing it too. He kept up with me the whole way, and without a wheelchair.

Two things are possible.

One, the name of the plane might be Lourdes.

Two, he may have been a Libor trader at one of the big banks.

We got an email response to some of our writings about Libor from Jay E. Simkin (The Stratecon Group, LLC). He said, “The term scandal describes actions that some may find unacceptable, perhaps even outrageous, but which are not necessarily illegal. Fraud is always unlawful.” Jay gave us permission to share his email. His views are in the Special Reports section of our website. Here is the link.

We do not know whether there is criminal activity, as alleged. The appropriate authorities may find out in due time. We do know that some larger banks have been targeted in the Libor investigation. More will be revealed.

Let’s look at how Libor-related banks have performed in a financial-sector ETF. The three US banks involved in Libor are Bank of America (BAC), JP Morgan (JPM), and Citi (C). Let’s examine the big-bank ETF that contains all three.

The symbol for that ETF is KBWB. It is the PowerShares-sponsored ETF of the Keefe, Bruyette & Woods, Inc. big-bank index. The weights of the three Libor banks in that ETF, as of 7/19/2012, are BAC (7.2%), JPM (7.2%), and C (6.4%).

How have they done? Let’s look at total return from the inception of KBWB (launched on 11/1/2011). We will also examine Wells Fargo (WFC), which is not a Libor bank, though it is also in the KBWB ETF.

From 11/1/2011 to 7/19/2012, the total return for the banks and KBWB itself are as follows. WFC is up 40%, BAC is up 14%, JPM is up 8%, C is down 9%, and KBWB is up 20%. That’s total return including dividends.

Wells Fargo outperformed everybody else. WFC is not a Libor-setting bank. A takeaway is that KBWB, which contains the three Libor-setting banks and Wells Fargo, plus other banks, has done fairly well. It’s up about 20% during the period. It captured the baseline return in its sector. It did not expose the investor to the negative results that one sees from Citi.

The lesson is that ETFs diversify risk. They can do this within a sector or more broadly, if used in that capacity. ETFs insulate against the downside risk that is more extreme with a single stock. KBWB vs. C is a good example. In return, the investor gives up some of the upside reward that one can also obtain from a single stock. WFC vs. KBWB demonstrates this side.

In our book From Bear to Bull with ETFs, we discussed some financial-sector ETFs. We tried to make the point that ETFs bring you the prospect of diversification, either within a sector or beyond it. ETFs may dampen the extreme risk. You don’t get the worst and you don’t get the best; you get the middle.

The Libor Scandal (I leave it to others to call it fraud) is a shock. Shocks have casualties. Some of the casualties are in the banking sector, but that doesn’t mean the entire banking sector is bad. In our view, the banking sector is cheap. The entire banking industry is collectively priced below its book value. KRE (regional banks) and KBWB are among the ETFs we use in that sector.

BY David R. Kotok