3 financial ETFs to own today

Diversification is the name of the game, and that includes regional banks that will benefit if interest rates rise.

By Benzinga Jul 24, 2013 1:16PM

The financial sector has been no slouch in 2013, easily outperforming the S&P 500 with a gain of 25%. That is, if you use the Dow Jones US Financial Index as the benchmark.

However, there is more to the finance sector than the big names that most investors are familiar with.

By diversifying money allocated to the financial sector across more than just the JPMorgans (JPM) or Goldman Sachs' (GS) of the world, an investor will lower risk and, if done right, could potentially increase reward.

This will take some thinking outside the box and the willingness to add several ETFs versus just one.

The SPDR Select Sector Financial ETF (XLF) is a diverse basket of 84 stocks that spread across insurance (26%), financial services (24%), commercial banks (18%), and capital markets (13%).

That being said, the top ten looks like a "who's who" of the finance world. Top holdings include Well Fargo & Co. (WFC), Berkshire Hathaway (BRKB), JPMorgan and Citigroup (C).

The ETF is trading at the best level in nearly five years and is having a solid year, up 27%. However, it does not give investors the exposure they should have to the entire financial sector.

Slightly outperforming XLF this year is the iShares Dow Jones U.S. Regional Banks ETF (IAT) with a gain of 29%. The basket of 58 stocks is heavily weighted towards two stocks, US Bancorp (USB) and PNC Financial Services Group (PNC).

The remaining regional banks give investors exposure to the U.S. banking industry that could do well if interest rates increase.

The major difference between the regionals and the mega-cap banks is the international exposure and risk. The regional banks are more concentrated on the U.S. banking sector that deals with deposits and mortgages versus extremely complex financial instruments. As interest rates increase, it could lead to an increase in deposits at the regional banks and a larger spread that should boost the bottom line.

If more risk is the name of the game, then the iShares Dow Jones U.S. Broker-Dealers Index ETF (IAI) could be an option. The niche ETF only has 22 stocks with the sole concentration being companies that offer investment services. The top holdings are Goldman Sachs, Morgan Stanley (MS) and Charles Schwab (SCHW).

With a gain of 34% this year, it has positioned itself as a leader in the financial sector. As long as the risk-on trade continues to be the overall strategy and equity markets hit new highs, money should continue the flow into the sector.

The perception of most investors is that one financial ETF will cover all bases, but this is not true. An investor could realistically own all three ETFs mentioned above and expect very different returns from year-to-year.

The market will dictate which of the three should be owned at any time. Today all three are positioned to move higher for their own reasons and investors could consider the trifecta heading into the end of the year.

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