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The Best ETFs in the Market's Top Sector

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Financials have been all-star performers over the past year, crushing the broad market in the process. The most popular financial ETF, the SPDR Select Sector Financial Fund (XLF - Free Report) , is now up roughly 40% in the past year, easily outpacing the next closest sector—consumer discretionary (XLY) at 34.4%-- and nearly doubling the S&P 500 in the time frame.

There are a number of reasons for this impressive performance in the financial space, as the sector has fought back from the crisis years and is now on solid footing. It also hasn’t hurt that macro risks have been largely reduced, while concerns over further losses in the banking sector are minor at this point.

Beyond these reduced risks, recent events have helped a number of companies in the space too, specifically the steeper yield curve. This has made it far easier for banking institutions to earn a solid profit—thanks to a wider spread—while it has also increased the income that many money managers can earn on their portfolios.

Finally, recent talk from the Fed and the shifting market has been a boon for security exchanges as well. This space has benefited from increased demand for its services—thanks to more interest in trading-- suggesting that 2013 has been a pretty great year so far for the entire financial sector (see 3 Surging Financial ETFs Beating the Market).

Best Plays in the Sector?

Financials have had a great run based on some of the above trends, and given the current market environment, there is no reason to believe that this cannot continue, especially with the sluggish earnings hitting a number of other sectors. While XLF could be a great play for the continuation of this trend, there are several more specialized financial ETFs that are also intriguing plays in this environment, and may be currently overlooked picks by many investors.

Below, we highlight three of our favorite ETFs in the financial space which have been outperforming XLF lately. These all have Zacks ETF Ranks of 2 or better too, and thus could also be well-positioned to take advantage of the market heading into 2013’s final stretch:

iShares U.S. Insurance ETF (IAK - Free Report)

This ETF tracks the Dow Jones U.S. Select Insurance Index, following a group of full line insurance, property and casualty insurance, reinsurance, and life insurance providers. In total, the fund holds about 70 stocks in its basket, charging investors 47 basis points a year in fees.

Property and casualty providers make up the most at about 50% of the portfolio, followed by life insurance (34%), and then full line (15.8%). Top holdings include AIG, Metlife, and Prudential, while roughly 60% of the portfolio goes towards the top ten stocks (read Time to Buy Insurance ETFs?).

IAK has performed well over the past three months adding about 10.5%, while it has moved higher by 43.5% in the past 52 week time frame. This fund has a Zacks ETF Rank #2 (Buy) and a medium risk rating, so its outperformance could definitely continue.

PowerShares KBW Bank Portfolio (KBWB - Free Report)

KBWB follows the KBW Bank Index, tracking companies that do business as banks or thrifts that are publicly- traded in the U.S. There are roughly two dozen companies in the basket—consisting mostly of national money center and region banks—while the fund charges investors a relatively cheap 35 basis points a year in fees.

The company has a nice mix of both big banking institutions, and smaller thrifts in its portfolio, though roughly two thirds of the assets are in large cap stocks. Some top holdings include the big four of Citigroup, JP Morgan, Bank of America, and Wells Fargo, although SunTrust, Regions Financial and M&T Bank round out the rest of the top seven (see 3 Sector ETFs to Profit from Rising Rates).

This ETF has added about 15.9% in the past three months, while it has moved higher by 43.7% in the trailing one year time frame. KBWB has a Zacks ETF Rank of 1 or ‘Strong Buy’ as well as a low risk rating.

iShares US Broker Dealers ETF (IAI - Free Report)

This fund follows the Dow Jones U.S. Select Investment Services Index, following about two dozen companies that are securities brokers and dealers, or exchanges. This fund charges investors 47 basis points a year in fees and has about $150 million in assets under management.

The ETF has a nice mix between asset managers and security exchanges, all of which look to benefit from the trends outlined above. Top holdings include companies like Goldman Sachs, Morgan Stanley, and the Schwab Corp, while exchanges like CME Group, ICE, and NYSE Euronext also make their way into the top ten (see Why IAI is a Great Financial ETF).

IAI has added 17.2% in the past three months, and it is up 51.8% over the past year. The ETF is currently a Zacks ETF Rank #2 fund, and it has a medium risk rating.  

Bottom Line

Financials have been crushing the market as of late, with broad products nearly doubling the S&P 500’s return over the past year. However, there have been a few funds in the space that have done even better, and could be better momentum plays in the sector heading into the tail end of the year.

These ETFs, IAK, KBWB, and IAI, have beaten out even the impressive XLF lately, and remain well positioned for more gains to close out 2013 as well. This is particularly true given their ‘buy’ ETF Ranks and the positive forces in the financial sector, making these ETFs overlooked picks for investors seeking quality exposure to the resurgent financial sector.

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