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 $559 billion of the more than $1 trillion in stock index funds as of the end of February -- a 29% increase over last year, but down $9.4 billion from January, itself down from the prior month.

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.

Last week, we noted that over the past year, large-cap stocks and funds began to outperform -- or perform less worse -- than their small-cap brethren. We pointed to Fool analyst Dan Caplinger's observation:

Over the past year, large-cap growth funds have risen 8.25%, while large-cap value funds fell nearly 2%. With smaller stocks, the disparity was even more dramatic, with small-cap value funds down over 11%, while small-cap growth funds eked out a 2% gain.

So we'll take a look this week at those large-cap ETFs with the best three-year performance, sorted by how they've fared over the past 12 months.

We'll then combine this information with the views of the collective intelligence of the 100,000 professional and novice investors at Motley Fool CAPS, to see which funds our participants have rated as the best.

Tread carefully here, Fools; while the market offers many ETFs, few have a long history. While all of these have a three-year performance standard -- an arguably important performance milestone -- only time will tell whether they can build similarly solid track records over five- and 10-year periods.

A strategy that pays dividends
Where the Russell 1000 looks at the top large-cap segment of the U.S. stock universe, the Value Index measures the performance of those Russell 1000 Index companies with lower price-to-book ratios and slower forecast growth.

That has set up a dichotomy of opinion about the index among investors. The top-rated All-Star analysts at NetScribeETF predicted last year that the Russell 1000 Value Index's fundamentals should help it do well. Like many analysts, they undoubtedly did not foresee the crumbling of the banking and financial sectors when they picked it to outperform:

Financial services account for more than a third of the corpus with representation from banking, thrift and mortgage, asset management, investment banking and brokerage houses. With no signs of interest rate hikes, alternative investments gaining importance and busy merger and acquisition schedule ahead make the sector a bright spot.

Remember, that was written more than a year ago, and those financial services companies sure didn't help since then.

In fact, investors like thorn969 saw technical reasons, along with some obvious practical ones, at the time of his underperform pick last November.

The market in general is looking bearish and the large-cap value sector has been weakest so far. It is not too late to short the stock; it is not yet oversold according to stochastics and it is trading at a slight premium relative to its NAV.

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.

Fool contributor Rich Duprey does not have a financial position in any of the funds mentioned in this article. You can see his holdings here. The Motley Fool has a world-class disclosure policy that has been around the world and back again.