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 mutual 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, tilting a portfolio away from the diversification that makes index investing attractive.

Today, we're looking at the best-performing exchange-traded funds over the past year. We'll then combine that information with the views of the collective intelligence of the professional and novice investors at Motley Fool CAPS, to see which funds our participants have rated as the best.

ETF

Net Assets

1-Year Return

3-Year Return

CAPS Rating (out of 5)

iShares MSCI Brazil Index (AMEX:EWZ)

$7.67 billion

98.51%

65.96%

*****

iShares FTSE/Xinhua China 25 Index (AMEX:FXI)

$177.53 million

94.45%

50.05%

***

Market Vectors Steel (AMEX:SLX)

$233.86 million

88.99%

NA

*****

Claymore/BNY BRIC (AMEX:EEB)

$1.1 billion

85.84%

NA

*****

PowerShares Golden Dragon Halter USX China (AMEX:PGJ)

$1.05 billion

78.73%

NA

****

iShares S&P Latin America 40 Index (AMEX:ILF)

$255.33 million

63.74%

55.05%

*****

BLDRS Emerging Markets 50 ADR Index (NASDAQ:ADRE)

$947.26 million

56.42%

44.13%

*****

Source: Morningstar. CAPS ratings courtesy of Motley Fool CAPS.

While there are many exchange-traded funds to choose from, they've gained in popularity only recently, so few have been around for any significant amount of time. For example, three of the top seven funds don't have even three years of history, although interestingly, the iShares FTSE/Xinhua China 25 Index has now accumulated enough time in the market to have a three-year track record. Last month, when we looked at similarly situated ETFs, the FTSE/Xinhua index hadn't yet been around long enough.

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.

Waxing poetic on Brazil
With China trying to put the brakes on an overheated investment climate by asking investment banks not to loan out more money for the rest of the year, the resilient Brazilian economy continues its own torrid growth. Investors like All-Star hondo928, with a 98.15 player rating, see such emerging economies continuing to outperform the U.S. markets:

I am bullish on emerging markets for ... the long-term and I think that a lot of the sizzle might be slowing down on China, so people turn to Brazil, Russia and India where the bull runs have been slightly more stealthy. The smart investor would look into BRI as well as South America, Greece, Turkey and other area, EWZ is a quick easy way to play the Brazil trend. I am thinking about pulling my money out of FXI into here.

A basket of opinions
Although ETFs have been around since the 1990s, investors might want to be cautious with any individual ETF that doesn't have a long track record. Head on over to CAPS to tell the community 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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