ETFs for Tomorrow

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 $569 billion of the more than $1 trillion in stock index funds as of Jan. 31 -- a 32% increase over last year, but down $39 billion from December.

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

Today, we're looking at the ETFs that exhibit the lowest beta. As a measurement of risk, beta is useful, though not comprehensive. For one thing, it looks primarily at only one specific criterion -- trading volatility -- but ignores other types of risk, such as 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.

We'll then combine that information with the views of the collective intelligence of the 89,000 professional and novice investors at Motley Fool CAPS, to see which funds our participants have rated as the best.

Tread carefully here, Fools: Although the market offers many exchange-traded funds, few have a long history. Here, though, only one of these ETFs doesn't have a three-year performance record, arguably an important milestone, yet only time will tell whether they can build solid track record over longer time periods.

A strategy that pays dividends
It shouldn't be surprising to find gold topping the performance charts, though it may seem surprising that the beta of the top-performing fund -- streetTRACKS Gold Shares -- is the lowest beta.

After an extended bull market, gold finally took a break last week -- along with a number of other commodities, such as oil -- after the Federal Reserve stepped in to try (once again) to restore calm and order to the financial markets. Yet no one seriously thinks we'll be returning to cheap oil or gold, at least not anytime soon. For example, CAPS player goofypicker doesn't think we're at the end of the "commodities bubble," if you want to call it that, for a number of very good reasons.

Gold and silver have taken a sudden drop during the past week. Many speculators are [panicking] and claiming that this is the end of the "commodity bubble". ... If you look at the fundamental reason behind the last 6 months rise in precious metals, you have to ask yourself ... has anything changed? I don't think so. The Fed continues to pump liquidity into the market, the interest rate continues to decline, inflation continues to increase and the dollar continues to fall. ... Precious metals will experience quite a bit of volatility and the gyrations may be tough to handle but I think ... that a year from now precious metals will be much higher.

On the other hand, the current climate is giving some investors deja vu. Says CAPS player alcear:

Reminds me of when the Hunts tried to corner silver. Next thing you know everyone is melting down [Grandma's] good silver. People are going through the jewelry box right now to sell what they don't wear. ... [However, fear] can only go so far. 20% correction coming.

A basket of opinions
Although ETFs have been around since the 1990s, investors should exercise caution with any ETF lacking a long track record. Over on CAPS, let us know whether you think these ETFs will continue to outperform, or whether it's time for new ones to top the lists.