ETFs for Tomorrow

As a Foolish strategy, investing in index funds can be substantial enough for an investor to build a financially rewarding portfolio. It supplies instant diversification across a broad cross-section of industries, relieves you from worrying about timing the market, and costs are low.

Putting an investment program of automatic contributions into an index fund gives Investor Jane Rich the benefits of dollar-cost averaging and saving regularly for the future. Warren Buffett once noted that his favorite time to sell was "never" -- and investing in index funds allows you to be just like the Oracle of Omaha.

That could explain why exchange-traded funds have become so popular. According to index-investing legend John Bogle, ETFs' assets totaled $420 billion out of the $1 trillion of equity held in index funds as of February.

A basket of stocks
ETFs, originally modeled after index funds, are mutual funds that trade like stocks. The first batch of ETFs, SPDRs ("Spiders") offered potentially even lower expense ratios than index funds, along with some additional tax efficiency. The ability to trade ETFs like stocks only added to their popularity, although increased tax and trading costs can erase any benefits from buying and holding an ETF.

Yet as ETFs proliferated, the ability to focus on more specialized industries became possible. That's been a boon to investors seeking to home in on certain areas of the market and buy a basket of stocks there. But it also concentrates the risk that accompanies such specialization and tilts a portfolio away from the diversification that makes index investing attractive.

Today, we're looking at the best-performing ETFs of 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, to see which funds our participants have rated as the best.

While there are many ETFs to choose from, few have been around for a significant amount of time. For example, SPDR S&P BRIC 40, SPDR S&P China, and Market Vectors Steel are less than a year old, and only iShares MSCI Hong Kong Index has a three-year return record to consider. Of course, even venerable mutual funds had to start sometime, so only time will tell if these ETFs can build a solid track record.

An international flavor
Not surprisingly, all of these top-performing ETFs represent international markets, with the world's fastest growing economy, China, represented among five of the seven. Yet it's the attraction of all such emerging BRIC markets -- Brazil, Russia, India, China -- that seems to capture most investor attention these days. As CAPS player Jeff11420 notes, it can give you exposure to the top companies underlying the ETF.

This is a BRIC play and a good way to load up on MT & RIO.

Or as fellow CAPS investor dobman69 puts it:

Steel and more steel from all the big makers in all the big countries.

Although no bears have ventured from hibernation yet to cast a vote against this ETF, it should be noted that this is a highly focused fund that seeks to follow AMEX's steel index.

A basket of opinions
ETFs have been around since the 1990s, but investors ought to be cautious with ETFs that don't have a long track record. Give your opinion at CAPS: Do you think these ETFs will continue to outperform, or is it time for new ones to ascend to the top of the lists?