After Moody’s Investor Service downgraded several major global banks, the sector has become closely watched. Investors are beginning to add financial exposure to their portfolios yet again, however, the large-cap institutions have been replaced by regional banks as prime choice.

“Clearly the U.S. economy has some risk because of Europe,” Erik Oja of S&P Capital IQ said, “but the regional banks are less volatile and risky than the big banks as they have almost no direct international exposure.”

The relative appeal of value that banks and the financial sector have in comparison to how cheap the sector is at the moment has triggered an investor migration back into focused shares and ETFs. David Sterman for Financial Adviser reports that about six months ago analysts were citing banking stocks as incredible bargains, as the financial sector was ready to rally. [7 Regional Bank ETFs Betting on M&A Activity]

A rally in the financial sector has failed to get off the ground due to Europe’s inability to cope with debt issues, and the recent downgrade of major banks by Moody’s. The nation’s largest banks just saw their debt downgraded by ratings agency Moody’s, which will raise each of the nation’s largest banks’ cost of capital.

Investors have started to flock to the financial sector via regional banks and exchange traded funds, a safer route than investing in the large-cap institutions. The regional banks are also quite inexpensive on terms of trailing profits or book value. Most regional banks trade for less than ten times projected 2013 profits, and right around tangible book value, reports Sterman. [Financial, Bank ETFs for Earnings Season]

However, regional banks move in tandem with the U.S. economy  and are subject to the same news and economic influences. An ETF can help mitigate the risk of single stock picking, while giving a portfolio valuable exposure. [ETF Chart of the Day: Regional Bank ETFs]

  • iShares Dow Jones U.S. Regional Banks Index Fund (NYSEArca: IAT) This ETF is expensive, at 0.47%, and exposure is tilted toward the largest U.S. regional banks.
  • SPDR S&P Regional Banking ETF (NYSEArca: KRE) An expense ratio of 0.35% is more affordable, and exposure covers a broad spectrum of regional banks.
  • First Trust NASDAQ ABA Community Index Fund (NasdaqGM: QABA) The fund avoids the top 50 largest banks in that index, providing a greater focus on the nation’s small, local banking franchises. The 0.60% expense ratio makes this the most expensive of the three ETFs.

Tisha Guerrero contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.