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Three Financial ETFs Outperforming XLF

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So far in 2012, the market has come storming back, erasing memories of the lackluster performance that many saw for much of 2011. Among the top performing sectors during this time have been those in the more economically ‘sensitive’ categories as a broad recovery becomes more likely in the U.S. and Europe continues to avoid a meltdown.

Beyond sensitive industries like materials and consumer discretionary, financials have also been a star performer in year-to-date terms. In fact, the most popular ETF in this segment, the Select Sector Financials SPDR (XLF - Free Report) is up over 21.5% since the start of the year, nearly doubling SPY in the same time period (read Top Three High Yield Financial ETFs).

Yet, while this performance has undoubtedly been impressive, investors should note that there are several other financial ETFs which have turned in even better numbers so far this year. While none of these funds are nearly as liquid or widely held as the behemoth of XLF, they have all managed to beat out the popular fund by a pretty wide margin (see Avoid Turmoil With The Community Bank ETF).

So for investors searching for different ways to play the financial space, any of the following three ETFs could be great picks. While the may have wider bid ask spreads than XLF, they have more than made up for this with a solid track record of performance in the current bull market environment.

iShares Dow Jones US Financial Services Index Fund (IYG - Free Report) - up 27.1% YTD

This targeted ETF focuses on the financial services industry of the U.S. and has is currently beating XLF by about 560 basis points so far this year. The product charges investors 47 basis points a year in fees and holds 111 components in its basket (read Bank On These Regional Bank ETFs).

Currently, the fund is heavily weighted towards banks and broad financial firms as these two industries comprise 33% and 25% of IYG, respectively. Additionally, investors should note that the product is heavily concentrated in the ‘big four’ banks of JPMorgan (JPM), Wells Fargo (WFC), Citigroup (C), and Bank of America (BAC - Free Report) . These four securities make up nearly 40% of the total assets alone.

RevenueShares Financial Sector Fund (RWW - Free Report) - up 27.5% YTD

For a different way to play financials, investors should take a look at RWW. Unlike many ETFs which are market cap weighted, this fund weights securities by top line revenues, meaning that stocks that do a lot of sales will receive higher weights than they would in many other product types.

This technique has certainly paid off so far this year, as RWW is currently beating XLF by about 590 basis points since the start of January. However, investors should note that the product has expenses of 49 basis points a year while volume is extremely low, coming in below 10,000 shares a day. This means that total trading costs could be higher thanks to relatively wide bid ask spreads.

Nevertheless, the performance of the fund over the past few months has certainly made up for this factor, especially when compared to the ultra popular XLF. From a holdings perspective, the fund also has a very different breakdown. Banks make up just 13% of the portfolio while broad financial services firms (28%) and insurance companies (39%) receive the top two spots (also read Three ETFs With Incredible Diversification).

In terms of top individual holdings, large financials dominate, but generally they are broad institutions or giant insurance conglomerates. That is largely because these firms have more revenues—although profit margins might be lower—giving them outsized importance in revenue weighted funds. As a result of this, Berkshire Hathaway (BRK.B), JPMorgan Chase, and Bank of America make up the top three weights in this fund, combining to make up nearly 30% of the total.

PowerShares KBW Bank Portfolio (KBWB - Free Report) - up 26.5% YTD

The best performing U.S.-focused financial ETF this year has been PowerShares’ KBWB. The ETF edged out the other funds on this list by just a few basis points but it has beaten XLF by about 520 basis points so far this year. The product sees good volume of about 560,000 shares a day even though it doesn’t have the largest amount of AUM; total assets are below $35 million.  

The fund’s relative unpopularity is quite curious, as it has the lowest expense ratio of the three and decent volume. Currently, the product charges just 35 basis points a year in fees, relatively low compared to others in the space. All this comes despite using a modified-market cap weighting system by KBW, a strategy that looks to only include about two dozen stocks in their basket (see Five Cheaper ETFs You Probably Overlooked).

This produces a fund which is heavily weighted towards banks and nearly nothing else. In fact, banking firms account for roughly two-thirds of the total exposure while financial services make up another 25% of assets. From a market cap perspective, large caps account for nearly 70% of the total while mid caps make up the rest.

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