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 $572 billion of the more than $1 trillion in stock index funds as of Nov. 30.

Originally modeled after index funds, ETFs have gradually narrowed to target specialized slices of the market. Although that's a boon to investors seeking specifically targeted investments, it also concentrates the risks of specialization, by 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 what our participants have to say about these funds.

ETF

3-Month Return

1-Year Return

CAPS Rating (Out of 5)

Ultra Oil & Gas ProShares  (AMEX: DIG  )

41.47%

55.79%

***

United States Natural Gas  (AMEX: UNG  )

39.43%

1.65%

***

Ultra Semiconductor ProShares  (AMEX: USD  )

37.66%

(15.22%)

**

United States Oil  (AMEX: USO  )

35.31%

99.91%

**

Market Vectors Steel ETF  (AMEX: SLX  )

34.86%

73.78%

*****

PowerShares DB Oil

33.95%

86.68%

**

PowerShares DB Energy

33.58%

78.06%

****

Sources: Wall Street Journal and CAPS.

Tread carefully here, Fools. The market offers many exchange-traded funds, but few have a long history. None of the ETFs on our list here has a three-year performance standard, an arguably important milestone, and only time will tell whether they can build similarly solid track records over longer time periods.

Climbing a wall of opportunity
If anything has done well these past three months while all else in the market has been running amok, it is oil. ExxonMobil (NYSE: XOM  ) reported profits of $10.9 billion last quarter and $42 billion over the past year, while Chevron (NYSE: CVX  ) also had a gusher year. The country's second-largest oil company reported earnings of $19.1 billion over the past 12 months, to continue the trend of four straight fiscal years of record results.

Alongside oil companies doing a booming business, the U.S. Oil ETF been one of the top performers for the past three months. It's also been a big winner over the past year, when it has virtually doubled in value as oil's price first broke through the $100-per-barrel barrier and continued up the ladder to its current level of more than $125. Some now claim we will see $200 per barrel sooner rather than later. U.S. Oil has profited from the surge because it seeks to mimic the performance of the spot price of West Texas Intermediate light, sweet crude oil.

With Saudi Arabia rebuffing recent U.S. attempts to increase production levels in an effort to lower prices, there appears to be no end in sight for rising fuel prices. Unlike the politicians who want to impose a windfall-profits tax on the oil producers, CAPS investor gbrehm points out that demand has driven oil prices higher and oil companies' profits even higher:

What will drive oil prices down? ... This country (world) is addicted to oil. Demand will not lessen without major technological breakthroughs. The [ones] the Oil companies have been holding back for years. Even then, it will take years (and $$$) to transition. The oil consumers have no choice but to [buy] what they need at whatever the oil producers ask. How else will you get to work?

Yet quite a few folks think oil's run-up is done for, at least in the short term. Top-rated All-Star investor jstegma thinks other factors will come into play to stifle demand -- Federal Reserve Chairman Ben Bernanke could step in, for example, to pop oil's bubble -- but that demand for alternatives that will ultimately change the direction:

Oil has gotten ahead of itself somewhat. Demand is inelastic in the short run, but in the long run having it priced this high will cause demand to shrink. The idea that we've suddenly run out of oil is a bit overblown. To be clear, yes, if we continue to grow demand for oil at the pace of the past 20 years for the next 20 years, we will be unable to meet the demand. However, the growth in demand will slow as alternative technologies become available and cities get tired of being crowded with cars and pollution.

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. The Motley Fool has a world-class disclosure policy that has been around the world and back again.


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