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The Best- and Worst-Rated Financial ETFs

The Ratings' evaluation model has yet to find a financial-services fund with a 'buy' rating.

The answer: not yet.

The question: Has Ratings' quantitative evaluation model recently found any financial-services exchange-traded funds with "buy" recommendations?

With most financial ETFs battered by the fallout from the credit implosion triggered by the subprime debacle, the best ETFs from that sector hold marks in the "C" range, equivalent to a "hold" recommendation, from Ratings.

The five-highest-rated and five-lowest-rated financial ETFs are summarized in the accompanying table.

Investors are cautioned not to buy the

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, which has risen sharply because its inverse movements to financial stock prices are amplified by leverage. If the industry recovers, it will head down at an equally geared velocity, as the performance of its "mirrored image" sibling, the

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aptly demonstrates.

With hundreds of performance and risk measures available, identifying worthwhile investments can be a daunting task. Ratings' quantitative model condenses all available fund data into a single composite opinion of risk-adjusted performance. There are also "reward" and "risk" grades. While there is no guarantee of future performance, Ratings' grades provide a solid framework for making informed investment decisions.

The grades can be interpreted as follows: A is "excellent" or "buy." B is "good" or "buy." C is "fair" or "hold." D is "weak" or "sell." And E is "very weak" or "sell." A plus or minus sign designates that a fund is in the top or bottom third of funds with the same letter grade.

The column of "Performance Ratings" in the accompanying table is based on a computerized evaluation of a fund's performance for a number of time periods, up to three years. More weight is given in the calculations to more recent time periods.

In determining Ratings' "risk" grades, the model evaluates volatility measures. In addition to standard deviation of returns, the evaluation process includes a metric known as "drawdown," which gauges a fund's most severe period of loss over a period of time.

Because all funds carry some degree of risk, none receive "risk" grades in the A range. Rarely will a fund be awarded a very high "performance" rating and, at the same time, a very high "risk" rating. A fund that has earned the highest "overall" investment ratings has attained an optimal combination of both primary components. But investors should be aware that a tradeoff always exists between risk and reward.

Richard Widows is a senior financial analyst for Ratings. Prior to joining, Widows was senior product manager for quantitative analytics at Thomson Financial. After receiving an M.B.A. from Santa Clara University in California, his career included development of investment information systems at data firms, including the Lipper division of Reuters. His international experience includes assignments in the U.K. and East Asia.