Like all modern economies, the financial sector is vital to a well-functioning and efficient economy. However, publicly-traded financial companies in Canada make up the largest sector in the overall S&P/TSX composite. Therefore, their performance drives the overall S&P/TSX index and the overall Canadian economy. So, Canadian Financials is arguably the “best” sector and the most important sector within the Canadian stock market that investors may want to gain exposure to through ETFs.  

Overview of the Canadian Financials Sector

Within the S&P/TSX index, Canadian Financials make up almost one-third of the index, comprising 31.7% of the overall index as of May 31st, 2022. As the largest sector within the index, it is clear that the performance of financials drives the overall Canadian market. The constituents that make up the largest amounts within the Canadian Financials sector include:

• The “Big Six” banks – Royal Bank of Canada (RBC), Toronto-Dominion Bank (TD), Bank of Nova Scotia (BNS), Bank of Montreal (BMO), Canadian Imperial Bank of Commerce (CIBC), and National Bank of Canada (NBC).
•  The “Big Three” life insurers – Manulife Financial Corporation, Sun Life Financial, and Great-West Lifeco
• Big asset managers – Brookfield Asset Management, Power Corporation of Canada, Fairfax Financial Holdings

Of course, there are many other financial companies. However, the companies mentioned above are the large drivers of the index due to their relatively large market capitalization.

The Financials sector is anchored by the Big Six banks, which have an oligopoly over the Canadian banking sector. This allows them to sustain strong pricing power and relatively high returns on equity. 

The large life insurers and asset managers are multinational companies which have expanded their operations past the horizons of the Canadian border, allowing them to achieve more significant growth opportunities and greater diversification of risks.

When do Canadian Financials outperform?

As mentioned, the Canadian Financials are primarily anchored by the banks. While the companies are considered to be banks, they are very diversified financial services companies that operate within:

• Retail banking 
• Commercial banking
• Capital markets
• Insurance

While the degree of exposure to each segment differs amongst the banks, the most significant driver is the retail banking segment. This is underpinned by the mortgage market and other personal loans (auto, credit cards etc.). Therefore, Canadian banks usually outperform when the housing market is strong, and consumer confidence is high. Furthermore, when rates are rising, and the yield curve is steepening, Canadian banks are more likely to increase their net interest margins.

Rising rates also benefit life insurers since these companies usually receive premiums from their products which are reinvested into fixed income securities. As yields increase on fixed income securities, life insurers' portfolios tend to generate more money.

Lastly, asset managers acquire companies (both publicly traded and privately held). Valuations typically are depressed during times of rising rates like we are currently seeing. So the performance of these asset managers is poor during a period of rising rates. However, it gives more opportunities to deploy capital at reasonable valuations.

Ways to Invest in Canadian Financials via ETFs

In general, rising rates are a net benefit for the largest Canadian Financial companies. However, the economic uncertainty will certainly outweigh these benefits. The Canadian Financials sector still remains a viable investment, especially during these uncertain times. The following are ETFs to gain exposure to the Canadian Financials sector.

XFN (iShares S&P/TSX Capped Financials Index ETF)

Summary: The overall Canadian Financials index encompasses all subsectors of the Canadian Financials space within the S&P/TSX index.

• AUM: $1,372M
• Expense Ratio: 0.61%
• YTD performance: -11.1%

HXF (Horizons S&P/TSX Capped Financials Index ETF)

Summary: The overall Canadian Financials index encompasses all subsectors of the Canadian Financials space within the S&P/TSX index.

• AUM: $59M 
• Expense Ratio: 0.27%
• YTD performance: -11.2%

ZEB (BMO Equal Weight Banks Index ETF)

Summary: ETF which tracks the performance of the Canadian Banks specifically.

• AUM: $2,993M 
• Expense Ratio: 0.28%
• YTD performance: -9.1%

FIE (iShares Canadian Financial Monthly Income ETF)

Summary: Income ETF which holds both equity and fixed income securities issued by Canadian Financial companies.

• AUM: $857M
• Expense Ratio: 0.89%
• YTD performance: -14.1%

Data for this article is as of June 22nd, 2022.

Disclaimer: This article is limited to the dissemination of general information pertaining to investment strategies and financial planning and does not constitute an offer to issue or sell, or a solicitation of an offer to subscribe, buy, or acquire an interest in, any securities, financial instruments or other services, nor does it constitute a financial promotion, investment advice or an inducement or incitement to participate in any product, offering or investment.