3 Funds Banking on Financial Stocks

NEW YORK (TheStreet) -- Financial stocks have been rallying. With banks reporting improving earnings, financial funds have gained 14.7% this year, outdoing the S&P 500 by 4 percentage points, according to Morningstar.

Some mutual fund portfolio managers argue that financial stocks can continue climbing. The managers have big stakes in banks, insurance companies and money managers.

Funds with sizable financial holdings include Davis New York Venture , Haverford Quality Growth Stock and Snow Capital Opportunity .

The bullish mutual funds are in a distinct minority. Many portfolio managers remain wary of the sector, concerned that profits could be hurt by new regulations in the U.S. and the continuing crisis in Europe. But Nate Snyder, portfolio manager of Snow Capital Opportunity, argues that the fears are excessive.

"We have endured the worst financial crisis in 70 years," he says. "The next big crisis is not likely for another 70 years. From here on, everything should improve."

Snow Capital, a large value fund, has 36.7% of assets in financials, compared to 12.4% for the S&P 500. Snyder says that many financials are cheap, based on book value -- the measure of a company's assets minus liabilities. In the past, financials typically sold for more than their book values. But now Snyder says that many solid companies sell for substantially less than their book values.

"When a stock sells for less than book, it means that investors are worried about the earnings or they question whether the business is viable," he says.

Snyder is particularly keen on life insurers, including MetLife , which has a price/book ratio of 0.63, and Prudential Financial , with a ratio of 0.76. He concedes that life insurers are depressed because of headwinds they face.

The problems stem from the fact that the insurers collect premiums and invest the cash in bonds. With interest rates low these days, bond income is skimpy. But Snyder says that both MetLife and Prudential have remained comfortably profitable despite the problems.

Haverford Quality Growth

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True to its name, Haverford Quality Growth Stock only takes rock-solid blue chips that seem poised to deliver steady results for years. In the past, the fund often paid premium prices to buy champion companies. But now even the best financials sell for big discounts to the market, says portfolio manager Tim Hoyle.

Hoyle concedes that many banks remain shaky. But he says that he can find a handful of names that can prosper in good and bad times. A holding is JPMorgan Chase , which came through the financial crisis in relatively solid shape.

The government's recent stress test showed that JPMorgan has the financial strength to survive a massive recession. The healthy balance sheet should enable the bank to expand globally, says Hoyle.

"They are going to be able to capture market share from the European banks, which have capital problems," he says.

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Hoyle also likes BlackRock , a money manager that has $3.5 trillion in assets under management. The company's growing iShares unit is the leading provider of ETFs. Hoyle expects BlackRock to increase dividends at a 20% annual rate.

Davis New York Venture

During the downturn in 2008, an outsized stake in financials hurt Davis New York Venture, a large blend fund. But Davis still has 31% of assets in the sector. Portfolio managers Chris Davis and Ken Feinberg say that their financial holdings sell at big discounts to their fair values. Many of the stocks have not risen in the past five years, even though the businesses have expanded substantially.

The Davis managers favor companies with solid balance sheets that can increase cash flows for long periods. They aim to pick stocks when they sell at significant discounts to their fair values. Once the fund buys, it holds for years. The annual turnover rate is a puny 8%.

The fund's biggest holding is Wells Fargo , a bank that is known for its conservative lending practices. Wells Fargo is still suffering from loan charge-offs that are connected to the acquisition of Wachovia at the depths of the financial crisis. But the Davis managers argue that the earnings should strengthen as the charge-offs decline in coming years.

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Another holding is Bank of New York Mellon , which is a dominant player in a variety of fields, including securities processing and asset management. Although earnings have grown substantially in the last five years, the shares have declined.