The XLF Financial Sector ETF Puts 25% of Your Money in Just Two Stocks

When investors talk about financial sector exposure, Financial Select Sector SPDR Fund (NYSEARCA:XLF) often comes up first. This ETF gives you a single-ticker way to own banks, insurers, payment processors, and asset managers. But here’s what matters: XLF isn’t a diversified portfolio. It’s a concentrated bet on mega-cap financials, with 86.2% of the portfolio in financials and the top two holdings representing nearly a quarter of the fund.

What XLF Actually Does in a Portfolio

XLF functions as a pure play on the financial sector’s health. You profit when banks earn more from lending, when insurers price risk profitably, and when payment networks capture transaction volume. The fund’s top two positions – Berkshire Hathaway (NYSE:BRK.B) and JPMorgan Chase (NYSE:JPM) – represent nearly a quarter of total assets, creating meaningful single-name exposure despite the ETF wrapper. Payment networks like Visa (NYSE:V) and Mastercard (NYSE:MA) add diversification within financials, but the concentration in mega-caps means performance hinges on whether these dominant players can sustain their competitive advantages.

The fund charges a competitive 0.1% expense ratio and maintains low turnover at 6%, reflecting a buy-and-hold strategy. The modest 1.3% yield signals this isn’t designed as an income vehicle – XLF works best for investors seeking financial sector beta without picking individual banks.

How It’s Performed When It Matters

Bank profitability depends heavily on net interest margins – the spread between loan earnings and deposit costs. As rate-cut expectations emerged, future net interest income projections weakened. This pressure explains XLF’s recent underperformance, with the fund delivering just 1.28% over the past year while the S&P 500 gained 11.81% as investors rotated away from rate-sensitive financials.

Over five years, XLF has slightly outpaced the S&P 500, compounding at 78.61% compared to 73.63%, but this modest edge came with higher volatility. Financial sector returns cluster around economic cycles – delivering strength during expansions with rising rates, but weakening when rate cuts signal economic concern or recession risk emerges.

The Tradeoffs You Accept

First, you’re taking massive sector concentration risk. When financials underperform, there’s no tech or healthcare cushion. Second, XLF is highly sensitive to interest rate policy and economic cycles. A recession hits this fund harder than diversified equity exposure. Third, the top holdings create single-stock risk despite the ETF wrapper. If JPMorgan or Berkshire stumbles, XLF feels it immediately.

XLF is best for investors who want targeted financial sector exposure and understand they’re trading diversification for sector purity, accepting that underperformance during rate cuts or recessions is part of the deal.