Regional Bank ETFs Fly Under Political Radar

NEW YORK (TheStreet) - At the end of last week, the media and Main Street ravaged Goldman Sachs(GS) after the SEC filed fraud charges. At the close of Friday's trading, the firm's shares had dropped more than 10%.

Now that initial gut reactions have subsided and the allegations of fraud are being more closely investigated, shares have slowed their decline but remain weak. On Tuesday, Goldman Sachs surprised with impressive first quarter earnings, but negative sentiment prevailed and GS shares trudged along in negative territory throughout the day despite strength in the rest of the market.

Ultimately, Goldman Sachs fraud allegations could either end up being the tip of the iceberg for the SEC or a way to push through controversial financial reform. No matter which way this scenario plays out, however, one thing is certain: Big Finance will likely continue to stay in Washington's crosshairs.

During this time, investors should steer clear of regulatory targets like Goldman Sachs. Other banks and financial institutions that could feel the burn from the ongoing Washington probe include JPMorgan(JPM), Bank of America(BAC) and Citigroup(C).

For ETF investors, washing one's hands of these Wall Street goliaths means avoiding large-cap focused financial instruments like the iShares Dow Jones US Financial Index Fund(IYF) and the SPDR S&P Financial ETF(XLF). GS, JPM, BAC and C account for 25% of IYF and 30% of XLF.

Instead, investors should seek out the less controversial players of the financial world which can fly under Washington's regulatory radar. This can be done through the various regional bank ETFs currently available.

Two options to consider include the iShares Dow Jones US Regional Banks Index Fund(IAT) and the SPDR KBW Regional Bank ETF(KRE).

Among the two, IAT is the more top heavy option with nearly 30% of its portfolio dedicated to its top two constituents. KRE, on the other hand, has only 5.5% of its portfolio dedicated to its top two positions. IAT's top two holdings are US Bancorp(USB) and PNC Financial Services(PNC). In KRE, Webster Financial Corp(WBS) and Synovus Financial Corp(SNV) command the top spots.

Interestingly, though both funds are designed for investors looking for a one-stop shop for regional banks, IAT and KRE are noticeably different in their approaches. IAT focuses heavily on the largest members of the regional banking industry. KRE, on the other hand, shows more dedication to the smallest players. Although both funds' indices have plenty of overlap, most KRE holdings that also appear in IAT's index represent slices smaller than 1% of IAT's portfolio.

Year to date, these two regional bank ETFs have beaten out their large-cap cousins by a large margin. IAT and KRE have both returned 25% during this period while XLF and IYF have gained 15% and 14%, respectively.

As seen by their past performance, regional banks have served investors well as the government continues to target large-cap financial players. Given the negative sentiment surrounding this industry, Goldman Sachs' issues won't go away overnight, and now the Europeans are looking into the bank. Financial reform is pressing forward, and the Republican opposition, instead of defending Wall Street, says the bill is too soft on the issue of "too big to fail." Until these matters are completed, the regional banks should outperform.

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