ETFs for Tomorrow

Investing in index funds can be all the Foolish strategy you need to build a financially rewarding portfolio. You get instant, low-cost diversification across a variety of industries, and you never have to worry about timing the market.

Making automatic contributions into an index fund gives an average investor all the benefits of dollar-cost averaging, making it easy to save regularly for the future. Warren Buffett once noted that his favorite time to sell is "never," and in that respect, index funds let you invest just like the Oracle of Omaha does.

That could explain why exchange-traded funds are now so popular. According to the Investment Company Institute, ETF assets totaled more than $507 billion of the more than $1 trillion in stock index funds as of August.

A basket of stocks
ETFs, originally modeled after index funds, are funds that trade like stocks. The first batch of ETFs, known as SPDRs ("spiders"), offered even lower expense ratios than many index funds, along with some additional tax efficiency. The ability to trade ETFs like stocks added to their popularity, although Fools should note that increased taxes and trading costs can erase any benefits from buying and holding an ETF.

As ETFs proliferated, they gradually narrowed their contents, from broad indexes to specialized slices of the market. That's been a boon to investors seeking to home in on certain areas of the market by buying a basket of related stocks. But it also concentrates the risk that accompanies such specialization, making it more risky than the more diversified S&P index.  

Today, we're looking at the exchange-traded funds that exhibit the lowest beta. As a measurement of risk, beta is useful, though not comprehensive. For one thing, it primarily looks at only one specific criterion -- trading volatility -- but ignores other types of risk, like size and event-specific items. Furthermore, ETFs that might be expected to fall less in declining markets will also rise less in surging markets. Still, in current conditions, ETFs that exhibit low betas might offer investors some peace of mind and make for an attractive investment.

ETF

Net Assets

Beta (3-Year)

3-Year Return

CAPS Rating (out of 5)

iShares Lehman 1-3 Year Treasury Bond (AMEX:SHY)

$8.92 billion

0.34

3.33%

*

Utilities Select Sector SPDR (AMEX:XLU)

$2.61 billion

0.41

20.41%

***

iShares Dow Jones US Utilities (AMEX:IDU)

$815.34 million

0.48

19.36%

**

Vanguard Utilities ETF (AMEX:VPU)

$310.96 million

0.50

19.79%

*****

Consumer Staples Select Sector SPDR (AMEX:XLP)

$2.01 billion

0.56

11.08%

**

SPDR DJ Global Titans (AMEX:DGT)

$194.72 million

0.59

13.01%

****

Vanguard Consumer Staples ETF (AMEX:VDC)

$335.31 million

0.61

13.00%

**

Source: Yahoo! Finance. CAPS ratings courtesy of Motley Fool CAPS.

While there are many exchange-traded funds to choose from, few have a long history. In the table above, beta has been calculated over a three-year period, meaning all of these ETFs have at least a three-year performance standard -- an arguably important performance milestone. Of course, even venerable mutual funds had to start sometime, so only time will tell if these ETFs can build as solid a track record over five- and 10-year time periods. Until then, however, investors would be wise to use caution.

In the Vanguard of performance
The top-rated fund here is offered by a family that should be well-known to investors: Vanguard. The company is known for the low fees charged on its mutual funds, and the two Vanguard ETFs shown here don't disappoint -- though the top-rated Utilities ETF doesn't sport the lowest expense ratio. Still, it's a passively managed portfolio that seeks to mimic the performance of the MSCI U.S. Investable Market Utilities Index.

CAPS All-Star Ludraman1, with a 94.78 player rating, likes Vanguard's utility player because it represents a stable sector:

A low cost ETF of World utilities ; good in case of a downturn - people still need to pay the bills.

That's the thinking behind CAPS player CKMayOrg's endorsement of the ETF -- that, and its low Sharpe ratio (a measure of a portfolio's excess return).

Too many good things to say about this ETF. Safe sector for a currently volatile market, great average returns, highest sharpe ratio of any similar ETFs (one of my favorite ways to compare ETFs), and it's Vanguard! Gotta love Vanguard, they never let me down.

A basket of opinions
Although ETFs have been around since the 1990s, investors might want to be cautious with any ETF that doesn't have a long track record. Give your opinion over at CAPS on whether you think these ETFs will continue to outperform, or whether it's time for new ones to ascend to the top of the lists.


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