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 $500 billion of the more than $5.9 trillion in stock index funds as of March 31.

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 best-performing ETFs over the past three years 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.

Tread carefully here, Fools. Although the market offers many ETFs, few have a long history. Only a handful of these have more than a three-year performance standard, and only time will tell whether the others can build similarly solid track records over longer time periods.

Climbing a wall of opportunity
"Flight to safety." Those words typically apply when the market is heading toward a recession. Over the past three years, the stock market has done well for itself -- it's risen more than 25% even despite recording a loss during the past 12 months. Yet that pales in comparison to how these ETFs have performed. The ones on our list today have been based on markets in developing economies such as Brazil and China.

This is part of the reason the analysts at Motley Fool Global Gains have stressed having an international outlook when you developing your portfolio. But is the tide turning? These markets aren't wholly dependent on the U.S. economy, but any pullback here at home will be felt overseas.

Moreover, because these economies have been so hot, it's bound to be reflected in these countries' inflation rates. Sure enough, Mexico's 4.55% is a three-year high, China's 8.5% rate was one of the fastest increases that country has experienced since 1996, and even India's inflation rate of 7.6% is a 42-month high.

Still, most investors remain excited by the prospects of international investing, particularly in the emerging markets. CAPS investor StormBroker finds the FTSE/China 25 Index attractive because it provides access to some of China's largest, most stable companies.

FXI (iShares China Fund), is an attractive means by which to track the growth of China's largest and most stable companies. Notable holdings include China Mobile, China Life Insurance, PetroChina, and others. China's boom is far from over and will continue over the next several years. However, I recommend FXI as a short-term play. Currently just over $150 after taking a close to 3% hit upon opening this morning, FXI is well under its 52 week high of $219. Look to buy FXI at $152 or lower and sell it above $160 for a nice short-term gain.

While that may be so, there are some top All-Star investors who urge caution, including CAPS player chk999, who sports a perfect 100.00 player rating:

If the U.S. stops importing so much stuff the [C]hinese economy slows sharply. At that point the overvalued stock market [re-enters]. And I don't think they have heatshields.

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.