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Small-Cap Bank ETFs Shine as Wall Street Languishes

While the financial sector remains one of the worst performing areas of the market, exchange traded funds that track small banks have quietly outperformed their large-cap peers.

Year-to-date, the First Trust NASDAQ ABA Community Bank Index Fund (QABA) rose 1.3%, PowerShares S&P SmallCap Financials Portfolio (PSCF) gained 9.7% and PowerShares KBW Regional Bank Portfolio (KBWR) increased 1.9%. QABA market-cap weights include small-cap 45.6% and micro-cap 35.4%. PSCF holds small-cap 65.2% and micro-cap 33.4%. KBWR includes small-cap 73.7% and micro-cap 6.1%.

Meanwhile, the SPDR S&P Bank ETF (KBE) fell 5.3%, SPDR S&P Regional Banking ETF (KRE) dropped 3.8%. KBE and KRE equally weight their component holdings and have a larger weights toward mid-caps, along with large-caps. Specifically, KBE includes a 10.1% tilt toward mega-caps, 14.7% to large-caps, 43.2% to mid-caps and 32.0% to small-caps. KRE includes 14.5% large-caps, 44.7% mid-caps, 36.8% small-caps and 3.9% micro-caps.

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The Russell 2000 Financial Services Index, a small-cap index of financial sector stocks, rose 7.8% this year on higher earnings and dividends as investors focused on domestically oriented banks that were less affected by global problems, reports Bailey Lipschultz for Bloomberg.

The divergence between the small- and large-cap segments is now at its widest in four years, with smaller financial services companies rising while large-cap banks were down 0.8%.

Related: Struggle and Trouble Ahead for Bank ETFs?

Small-cap financials are also now trading just 1.8% shy of their all-time high from 2007 while large-caps are 37% below their record peak.

“With the markets hitting new highs, risky assets like small caps have been able to bounce back much better and quicker,” Michael Arone, the chief investment strategist at State Street Global Advisors’ U.S. intermediary business, told Bloomberg.

Arone argued that the resilience of the U.S. economy and consumers will disproportionately benefit smaller banks. Meanwhile, larger banks are still suffering from a year of global volatile, notably the United Kingdom secession vote and China’s currency devaluation.

“We’re seeing the domestic economy acting much healthier than those overseas,” David Joy, the chief market strategist at Ameriprise Financial Inc., told Bloomberg. “When the economy is doing well and the markets rally, financials tend to be moving in a positive direction as well and that especially benefits those smaller-cap or regional companies.”

Related: Potential With a Small-Cap Bank ETF

Looking ahead, analysts project small-cap bank stocks to increase earnings by 22% this year and 11% in the next, compared to a 6% and 10% rise for those in the S&P 500.

Moreover, after underperforming the broader market, financials may soon get their moment in the sun as a value play.

“Financials have been suppressed and underweight this year,” Joy added. “But the way the market is shaping up, financials as a whole will do much better in the second half, and that would definitely move and carry the small caps to new levels.”

Click here to read the full story on ETF Trends.

PowerShares S&P SmallCap Financials Portfolio