Please Note: Blog posts are not selected, edited or screened by Seeking Alpha editors.

Forget the XLF, Meet the XFN

With valuations of financial firms at historic lows, many investors are looking to buy into the sector in hopes of profiting from the inevitable share price recovery. Those looking for broad exposure to the industry often find the Financial Select Sector SPDR Fund (XLF), which tracks about 80 US bank stocks. The XLF is cheap, up 10% in the past month, and is the third most heavily traded US-listed ETF. It has a less popular competitor, however, which has performed better in the past and has much brighter prospects for the future.

The TSE listed iShares CDN Financial Sector Index Fund (TSE:XFN) tracks an index of 24 large Canadian banks and diversified financials. It has performed admirably during the financial crisis, up nearly 20% YTD and down only half as much as the XLF on the year.

What's most remarkable about Canada's XFN, however, is its outperformance over the long term. Even at the height of America's housing bubble -when American banks gorged on lucrative and unsustainable origination fees- Canadian banks savagely outearned their American peers, and managed to practice risk management while doing so. Investors who bought the XLN in spring of 2001 are up 43%. Those that bought the XLF have lost half their money.

The Canadian advantage isn't purely a function of US decline. The Canadian banking sector is structurally more profitable, mainly because it is more consolidated.The five largest banks in Canada hold over 85% of the assets, a situation that reduces competition and raises margins. Canadian banks in many ways resemble utilities, exempt from anti-trust laws in exchange for heavy regulation. They charge hefty fees - even for basic consumer services - and earn high rates of interest.

Toronto is now home to 4 of North America's 10 largest banks, more than any other city on the continent. Canada's banking sector resembles the American economy after WW2. With its competitors in ruins, Canada's banks are ready to expand globally, scooping up good assets at firesale prices and exporting their profitable risk management expertise. And with Bank United now being shopped to the Cannuks, even the best banks in America may soon be priced in Loonies.

Disclosure: None