Bank-linked funds lure money, losses

Funds that invest in banks and brokerages are luring the most money this year even as the shares they buy post their biggest declines in almost five decades because of mounting credit-market losses.

Exchange-traded funds (ETFs) linked to baskets of financial shares raised $8.67 billion during the first seven months of the year, the most of 94 investment categories tracked by research and investment firm Birinyi Associates.

More than $500 billion of subprime-related losses pushed banks in the Standard & Poor's 500 index down 54 percent from its 2007 record, the biggest drop since at least 1962, Birinyi data show.

Investors were rewarded recently after the government agreed on a plan to rescue Fannie Mae and Freddie Mac, the biggest U.S. mortgage-finance companies, while curbs on short selling spurred a rebound in banks.

State Street Corp.'s $7.33 billion Financial Select Sector SPDR Fund surged 20 percent through Aug. 13 since sinking a month earlier to the lowest level since its 1998 creation.

"It goes completely counter to what you read, that everybody is selling, everybody is bearish, everybody is shorting financial stocks," said Birinyi's Robert Leiphart, who helps manage $350 million in Westport, Conn. "When people say, 'It's the worst it's ever been,' it's usually the bottom and the time to start to buy."

In a short sale, investors borrow securities and sell them on the expectation they can be purchased at a lower price later and returned to the holder.

Financial companies grew to the biggest of 10 industries in terms of ETF assets, with a combined $21.3 billion, Birinyi data show. Funds owning energy producers, the second-biggest category and the best-performing stocks for most of 2008, had outflows.

Financial shares in the S&P 500 have been this year's worst performers just as they were in 2007. Since last March, the world's biggest banks and brokerages have been forced to raise more than $350 billion to replenish capital, diluting existing shareholders, according to data compiled by Bloomberg.

Investors in the ETFs are wagering the shares are inexpensive after the retreat left S&P 500 financial companies with a price-to-book value ratio as low as 0.97, the cheapest since at least January 1995, and a dividend yield exceeding 5 percent for the first time in that span, Bloomberg data show.

Some investors are putting money into bank funds to hedge short positions on financial stocks, not to bet on a rally, said Dodd Kittsley, a senior investment strategist at Barclays Global Investors, which manages 163 ETFs that trade in the U.S.

"The average investor is buying into ETFs and financial sector funds" even as owners of financial stocks "seem to be panicking," said David Dreman, founder of Dreman Value Management in Jersey City, N.J. "Normally, investors shy away from groups that are getting clobbered."