The majority of economists are predicting a late 2009 or early 2010 economic recovery, and the recent upswing in the market has been bolstered by some of the sectors that were beat up the most in the recent crisis. As "zombie" banks are separated from healthy banks on the rebound, the financial sector is gaining momentum.

When it comes to financial ETFs, investors have an increasingly large selection, from broad-based indices to specialized subsector funds. The Financial Select Sector SPDR ( XLF), PowerShares Financial Preferred ( PGF) and iShares Dow Jones U.S. Regional Banks ( IAT) funds represent different approaches to the financial sector and different methods for investors to position themselves for recovery.

Financial Select Sector SPDR

Type: Broad U.S. financial sector ETF. Others in this category: iShares Dow Jones U.S. Financial Sector Index Fund ( IYF), iShares Dow Jones U.S. Financial Services Index Fund ( IYG) and Vanguard Financials ETF ( VFH).

What it does: XLF tracks the Financial Select Sector Index (^IXM). The goal of the fund is to provide a low turnover fund with a low expense ratio. XLF includes: diversified financial services; insurance; commercial banks; capital markets; real estate investment trusts (REITs); consumer finance; thrifts and mortgage finance; and real estate management and development.

Who it's for: The top holdings in XLF, the granddaddy of financial ETFs, have been some of the hardest hit by the recent financial crisis. But as the market has proved recently, some of the hardest hit equities have bounced the fastest. Prospective investors should be mindful of the risk/reward factor when considering XLF.

Since XLF offers such a broad exposure to the sector, investors should also be mindful of overlap in their portfolio between XLF and other major ETF index funds such as SPY. XLF is a top-heavy ETF with more than 54% of the fund's assets concentrated in the top 10 holdings. Finally, prospective investors should keep an eye on top XLF components as different banks process the financial crisis.

Top 10 holdings: JPMorgan Chase ( JPM), Wells Fargo ( WFC), Bank of America ( BA), Goldman Sachs ( GS), Morgan Stanley ( MS), U.S. Bancorp ( USB), Bank of NY Mellon ( BK), American Express ( AXP), Metlife ( MET), Travelers Companies ( TRV).

Liquidity and fees: XLF has a low 0.21% fee. The three-month average daily trading volume is 228,334,000

PowerShares Financial Preferred

Type: Financial preferred ETF. Others in this category: iShares U.S. Preferred Stock ( PFF).

What it does: PGF tracks the Wachovia Hybrid & Preferred Securities Financial Index. The underlying basket currently includes 40 holdings comprised of U.S. listed preferred stocks.

Who it's for: Investors looking for a high-yield option in the financial sector. Preferred shares have both debt and equity aspects, and PGF is likely to be more volatile than other regular equity financial ETFs. Preferred stock securities, like those found in PGF's portfolio, are taxed with the same 15% rate as common dividends. This 15% rate compares favorably to the rate that investors would pay on fixed income or bond interest payments, which are taxed as ordinary income at the maximum tax rate.

Top 10 holdings: (coupon rate, rating). Bank of America (BA, 8.20%, BB-/B3), Barclays ( BCS) (8.13%, BBB+/Baa2), JPMorgan Chase (8.63%, BBB+/A2), Wells Fargo (8%, NR/B2), Allianz (ALL.PA) (8.38%, A+/A3), HSBC Holdings ( HBS) (8.13%, A-/A1e), Metlife (6.50%, BBB-/Baa1), ING ( ING) (8.50%, BBB/A3), Bank of America (8.625% PD 8.63%, BB-/B3), Credit Suisse ( CS) (7.90%, NR/Aa3).

Liquidity and fees: The portfolio is rebalanced monthly and has a 0.60% fee. The three-month average daily trading volume: 1,529,480.

iShares Dow Jones U.S. Regional Banks Index Fund

Type: Banking ETF. Others in this category: KBW Bank ETF ( KBE), KBW Regional Banking ETF ( KRE), Merrill Lynch Regional Bank HOLDRs ( RKH) and PowerShares Dynamic Banking Portfolio ( PJB).

What it does: IAT tracks the iShares Dow Jones U.S. Select Regional Banks Index, which is composed of small and midsize regional U.S. banks. IAT employs a three-year asset weighting methodology to determine which regional banks will be included in the fund.

Who it's for: While regional banks have traditionally offered investors more conservative exposure to the banking industry, many of the large regional banks have been ensnared by the same mortgage difficulties as their large-cap peers. Since IAT has a capitalization-weighted methodology, investors should be mindful that a large portion of the holdings will be held in the largest of the regional banks.

IAT's top holding, Fifth Third Bancorp ( FITB) comprises nearly 19% of the portfolio. This concentration makes IAT's investors particularly sensitive to FITB's news and intraday trading patterns. As healthy banks are weeded out from "zombie" banks, IAT could be a good instrument to pick up exposure to regional banks that weather the crisis.

Top 10 Holdings: U.S. Bancorp, PNC Financial Services ( PNC), BB&T ( BBT), Northern Trust ( NTRS), Hudson City Bancorp ( HCBK), SunTrust ( STI), Regions Financial ( RF), MT&T Bank ( MTB), Fifth Third Bancorp, New York Community Bancorp ( NYB).

Liquidity and fees: IAT has a 0.48% fee. The three-month average daily trading volume is 523,346.

Before investing in any financial ETF, you should examine your risk/reward tolerance. When scouting financial ETFs in particular, however, investors should be particularly sensitive to top-heavy portfolios where a single component could sway the entire investment.

For an overall large-cap exposure to the sector, XLF might be the best choice for cautious investors just tiptoeing back into financials. PGF and other preferred ETFs offer a more fixed-income approach to financial sector investing, while subsector ETFs like IAT allow investors to pick niches that they believe will flourish.
Don Dion is the President and Chief Investment Officer of Dion Money Management and the Publisher of the Fidelity Independent Adviser family of newsletters. He provides commentary on the financial markets, with a specific emphasis on exchange traded funds and mutual funds to his clients and subscribers.

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