For Bank ETFs, The Index Matters (KBWB, KBE, XLF)

It's no secret that the financial services group, the second-largest sector weight in the S&P 500 behind technology, has rebounded in impressive fashion this year and those good times just kept on rolling last week ahead of the release of the Federal Reserve's stress test results. Even downtrodden Bank of America

and Citigroup

have notched year-to-date gains of roughly 70% and 40%, respectively. Predictably, that has been good news for an array of ETFs that track bank stocks, but not all of these ETFs track the same index and that leads to some divergence in terms of returns. In a research note, Keefe, Bruyette & Woods calls attention to the outperformance offered by its KBW Bank Index (

) relative to other financial services indexes. The PowerShares KBW Bank Portfolio

is the ETF that tracks BKX after PowerShares introduced four new ETFs

late last year. The PowerShares KBW Bank Portfolio has outperformed the rival SPDR S&P Bank ETF

year-to-date by 3.5% as of March 19. "The modified market-cap weighting of the BKX is the main reason that the KBWB is outperforming the KBE in 2012. The BKX better captures the performance of the largest banks since those have a higher weighting in the index. For investors seeking a long or short exposure to large-cap banks, the KBWB delivers that exposure. In the end, we believe that the BKX index would capture the performance of the largest banks most accurately whether the market is moving up or down," according to the KBW note. Said differently, KBWB follows an index that is modified market-cap weighted while KBE's index is equal-weighted, meaning that when the largest U.S. banks by market value are leading financial services rally, it's likely that KBWB will outpace KBE. Along those lines, it's also worth noting KBWB and KBE have outperformed the Financial Select Sector SPDR

this year. Assuming that Bank of America retains its leadership status throughout 2012, it would be reasonable to expect KBWB to continue outperforming KBE. BofA is KBWB's top holding at 8.63% of that fund's weight and even though the stock is also KBE's largest holding, it accounts for just under 3% of that ETF's total weight. "Large-cap banks in the S&P 1500 have risen nearly 30% in 2012. A large portion of this outperformance could be attributed to the performance of Bank of America, which has risen over 70% this year. Therefore, an ETF without appropriate exposure to a large-cap bank that is heavily outperforming would be lagging. That is exactly what is happening to some degree to the KBWB and to a greater degree to the KBE," KBW said. KBE trailing KBWB might be a bitter pill for long-term investors in the SPDR fund to swallow because KBE used to track the KBW Bank Index before State Street Global Advisors abandoned it in favor of the S&P Banks Select Industry Index (SPSIBK). Both ETFs have an expense ratio of 0.35%, which is nearly double the 0.18% charged by XLF. Follow me on Twitter: @ETFProfessor1