ETFs for Tomorrow

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Index funds have long been a Foolish way to gain instant, low-cost diversification without worrying about timing the market. Their ease and convenience may explain the growing popularity of exchange-traded funds -- mutual funds that trade like stocks. According to the Investment Company Institute, ETF assets totaled more than $608 billion of the more than $1 trillion in stock index funds as of Dec. 31.

Originally modeled after index funds, ETFs have gradually narrowed to target specialized slices of the market. While that's a boon to investors seeking specifically targeted investments, it also concentrates the risks of specialization, tilting a portfolio away from the diversification that makes index investing attractive.

Today, we're looking at the best-performing ETFs over the past three months and then combining that information with the views of the collective intelligence of the professional and novice investors at Motley Fool CAPS. We'll see which funds our participants have rated the best.

Exchange-traded Fund	3-Mo. Return	1-Yr. Return	CAPS Rating (5 max)
UltraShort Semiconductor ProShares	38.44%	25.2%	*
UltraShort MSCI EAFE ProShares	33.05%	NA	NA
PowerShares DB Agriculture   (AMEX: DBA)	32.23%	51.3%	****
UltraShort Technology ProShares	31.04%	12.9%	*
iPath DJ AIG Grains TR Sub-Idx ETN  (NYSE: JJG)	29.38%	NA	****
UltraShort QQQ ProShares (AMEX: QID)	28.10%	1.4%	*
iPath DJ AIG Agriculture TR Sub-Idx ETN  (NYSE: JJA)	24.69%	NA	*****
First Trust ISE Chindia  (NYSE: FNI)	22.57%	NA	****
UltraShort Russell2000 Growth ProShares  (AMEX: SKK)	22.26%	NA	**
UltraShort FTSE/Xinhua China 25 ProShares  (AMEX: FXP)	20.13%	NA	***

Source: Yahoo! Finance, The Wall Street Journal. CAPS ratings courtesy of Motley Fool CAPS.

Tread carefully here, Fools. The market offers many ETFs, but only a few have long histories. None of these ETFs has a three-year performance record, and only the fund shorting the NASDAQ market has a one-year standard to measure. Only time will tell whether they can build solid track records over longer time periods.

Climbing a wall of opportunity
Speaking of funds that short the market, you'll notice that more than half of these top-performing ETFs are designed to short their respective benchmarks. In the short term, a shorting strategy can be effective, but over longer periods markets tend to rise. It is important to investors to choose their targets carefully.

Except in the bowels of a recession or depression, you would be hard-pressed to find a long-term shorting strategy that works. Are we entering such a market now?

CAPS investor hicksjmu567 noted in November the market was trending lower and that an ETF like the UltraShort QQQ was bound to be a winner.

This is an ETF which shorts all of the stocks in the NASDAQ100 (computer hardware and software, telecommunications, retail/wholesale trade and biotechnology). If it would short Financial and Real Estate securities too I would have to buy some in real life.
It pains me to say this, but retail & tech stocks are approaching a bear market so for the short term I'm picking this ETF to OUTPERFORM.
I don't understand why there are a number of allstars picking this to underperform.

More recently CAPS player PTRio struck the appropriate stance in acknowledging the risks associated with taking a too-long-term view with this short ETF.

This ETF should be used as a short term investment when the market is expected to decline, as has been occurring since late December. Yes, it offers 2X the return in those situations, but when the market goes up you get slapped with 2X the loss. This investment should be monitored closely.

A basket of opinions
Although ETFs have been around since the 1990s, investors should exercise caution with any that lack long track records.

Over on CAPS, let us know whether you think these ETFs will continue to outperform or if it's time for new ones to top the lists.