Time to Bet on Banks, XLF?

Whether it is because the sector is often home to a firestorm of controversy or because it is the second-largest industry weight in the S&P 500, the financial services group often finds itself in the limelight. Between J.P. Morgan Chase's JPM London Whale imbroglio and the Barclays BCS LIBOR fiasco, it is not surprising that some banking ETFs have struggled over the past several months. What may surprise some investors is that a few bank ETFs have proven durable in the past month. One standout among the group is the largest bank ETF of all: The Financial Select Sector SPDR XLF. In the past month, XLF, which is home to almost $6.6 billion in assets under management, has risen 1.1 percent. XLF's diversity may be one reason the fund has outperformed the broader market recently and that diversity could set the tone for more upside. "There are some interesting things going on in financials right now, but XLF looks pretty good," Street One Financial Scott Freeze said in an interview with Benzinga. "Some of XLF's top-10 holdings are looking pretty strong." XLF's top-10 lineup includes Wells Fargo WFC and Berkshire Hathaway BRK, two stocks that combine for 18.5 percent of the fund's weight. The fund's top-10 holdings also include seemingly always controversial names such as J.P. Morgan Chase, Bank of America BAC and Citigroup C. That trio combines for over 16 percent of XLF's weight. While XLF is the largest financial services ETF, the fund does not feature excessive exposure to broker-dealer and capital markets names. That might be serving the ETF well, Freeze notes. "I don't think the broker-dealer space is strong right now," Freeze said. "Morgan Stanley MS not being a top-10 holding in XLF is helpful." Morgan Stanley accounts for just 1.22 percent of XLF's weight while rival Goldman Sachs GS receives an allocation of 2.7 percent. Another ETF that Freeze likes is the iShares Dow Jones U.S. Financial Sector Index Fund IYF. The iShares Dow Jones U.S. Financial Sector Index Fund charges 0.47 percent compared to 0.18 percent for XLF. However, IYF has been the better performer in the past month, gaining almost 1.6 percent. "Even if the market falls, IYF and XLF have enough diversity to hold up pretty well," Freeze said. What diversity means in the case of these two ETFs is offering investors exposure to financial services names beyond investment and money center banks. For example, XLF features American Express AXP and Simon Property Group SPG among its top-10 holdings. IYF offers decent exposure to credit card stocks, a sub-sector of the financial services space Freeze thinks will outperform in the coming months. The ETF allocates almost eight percent of its weight to Visa V, American Express and Mastercard MA. The bottom line is financials could provide some upside surprises for investors in the back half of 2012. "Financials could outperform for the rest of the year," Freeze said. "A lot of the bad news is priced in. Investors will get upside exposure with limited downside risk if the market rallies with XLF." For more on financial services stocks, click here.