There’s a bit of confusion over index ETFs for some investors. Exchange-traded funds that are tied to an index are indeed ways to march in lockstep with the major indices — the widely held SPDR S&P 500 ETF (NYSE:SPY), for instance, has a remarkable $80 billion in assets from investors who just want to “buy the market.”
But don’t be fooled. While the SPDR S&P 500 fund and the similar SPDR Dow Jones Industrial Average ETF (NYSE:DIA) are tied directly to the indices for which they are named, there are a host of index funds out there with very focused strategies. These ETFs focus on certain sectors or certain investment classes and thus can be a very simple and effective way to focus a limited amount of cash on a great investment opportunity.
So what sectors and related ETFs are performing the best right now in this volatile stock market? Take a look for yourself with these five high-flying funds:
The utilities sector has been red-hot in 2011. You might think this is absurd since utility stocks are quite boring investments. It’s not like a power company in Florida is going to see its profit double from quarter to quarter — unless rates double or the number of citizens increases dramatically overnight. They are legalized monopolies that largely plod along and pay dividends, but not much more. But it’s this very stable nature of the utility sector that has brought in buying pressure from risk-averse investors.
Take the Utilities SPDR ETF (NYSE:XLU), which is up 7% so far in 2011, compared with a 2% slide for the broader market. The icing on the cake is that XLU pays a 4% dividend because of its many cash-rich and high-yield holdings that include The Southern Company (NYSE:SO), Exelon (NYSE:EXC) and Dominion Resources (NYSE:D).
Big demand for utility stocks in this troubled market environment means big gains for XLU and other utility ETFs. The great dividend yield also is a selling point.
Buying bonds can be a confusing business for many investors. Do you really want to tie up your money for a decade in a 10-year T-Note? Are “junk” bonds safe? Who the heck do you call to buy and sell bonds anyway?
Take the guesswork out of bond investing with an ETF. It’s not only easier on you — it’s also pretty good for your portfolio. Some of the top-performing funds of 2011 have been bond ETFs as investors look to get out of the stock market and into low-risk, income-focused investments. Here are a few top bond funds to consider:
The PIMCO 25+ Year Zero Coupon U.S. Treasury ETF (NYSE:ZROZ) is a mouthful, but it is up 40% so far this year. Why? It’s complicated, but the simplest explanation is that many zero coupon bonds are tied to inflation — and as inflation heats up, the value of those bonds rise. Many investors are banking on inflationary trends over the long term, hence a big recent rally for this bond fund.
The PIMCO Build America Bond Strategy ETF (NYSE:BABZ) invests in (obviously) Build America Bonds that are used to fund municipal projects like roads and bridges. The rate of return on these bonds can be significantly better than the rock-bottom rate of U.S. Treasuries, but they carry a very low risk of default. Build America Bonds also carry special tax credits and federal subsidies to boot. All this has led to a nice 15% gain for BABZ in 2011 while the broader market is down.
The iPath US Treasury Long Bond Bull ETN (NYSE:DLBL) is not a fund with bond assets, but rather an exchange-traded note that looks to profit from the change in overall yields. The DLBL fund provides returns based on an increase or decrease in the yields of long-term U.S. Treasury bonds. And obviously since rates are rock bottom and have nowhere to go but up, DLBL has been doing quite well — up 35% so far in 2011.
In what is likely the no-brainer of the year, investors looking for a market-beating opportunity right now should consider turning to gold. The two leading physical gold ETFs — SPDR Gold Trust (NYSE:GLD) and the iShares Gold Trust (NYSE:IAU) — are both up 18% year to date in 2011. That’s even after gold prices have rolled back from highs over $1,900 this summer to under $1,700 right now.
Gold mining stocks had been outperforming the market nicely this year until a few weeks ago when the bottom fell out of the sector as gold prices flopped. The Market Vectors Gold Miners ETF (NYSE:GDX) has suffered a 10% drop in less than a month to put it in the red so far this year — but as recently as September, GDX was sitting on a 5% gain in 2011. There is a chance that this fund is a bit oversold as miners like Barrick Gold (NYSE:ABX), Newmont Mining (NYSE:NEM) and Goldcorp (NYSE:GG) have been held back in recent weeks.
As investors look to take shelter in hard assets, gold is one of the big fall-back investments right now. These ETFs provide an easy way to play the gold rush without worrying about storing physical gold bars in your basement.
Short ETFs or Inverse ETFs
Shorting the market is a strategy that doesn’t sit well with many investors. After all, it seems a bit morbid to profit as others are suffering. But in this difficult market, where there’s not a whole lot of upward momentum to be had, it can be in your best interest to consider a focused play on a specific part of the market you believe is in for some trouble.
Think the market is set to take a spill? Consider the ProShares Short S&P 500 ETF (NYSE:SH). It’s not a 1-to-1 inverse play on the market because of fees and the logistics of a short-selling strategy. But it is indeed a directional play — and one that you don’t have to research strike prices or options expiration dates to buy into. Think emerging markets are overbought? Consider the ProShares Short MSCI EAFE Fund (NYSE:EFZ) that goes up as the MSCI EAFE emerging market index goes down (that’s short for Europe, Australasia and Far East, if you’re wondering).
There also are supercharged sector-focused ETFs that play a particular industry. Take the Direxion Daily Financial Bear 3X ETF (NYSE:FAZ), which profits as the financial sector declines — three times over! This leveraged ETF is a very risky play, but consider that FAZ almost doubled in a few weeks across late July and early August as the market volatility eviscerated the financial sector. If you were one of those investors who had nothing but bad things to say about the banks and saw this crash coming, you could have played the downside this trade.
Remember, short-side ETFs and leveraged ETFs like the 3X financial fund discussed here are a bit riskier than other funds. They tend to charge you more in fees due to their intensive strategy and active management necessary for such strategies. But if you have strong feelings about a short-term directional play in the market, these ETFs are a very easy and effective way to spice up your portfolio and beat the market.
After all, why settle for beating the market with smaller losses when you can profit from a downward move with funds like these?
We come full circle to the idea of income stocks. As with the utility sector ETF highlighted first, the broader idea of dividend stocks and income investments is very appealing right now. Investors are looking for safe havens that pay them even in tough times — and stable, cash-rich dividend stocks are the way to go.
What better way to tap into income than the WisdomTree Dividend ex-Financials (NYSE:DTN)? This fund invests in dividend payers but avoids financial stocks because of their toxic and uncertain balance sheets right now. The result is a 3% gain so far in 2011 and a 3.2% dividend yield. Not bad. There’s also the First Trust Morningstar Dividend Leader ETF (NYSE:FDL) with similar performance and yield.
The correlation to the market with these plays still is very strong because you are essentially buying the blue chips of the S&P 500 and Dow that pay decent dividends. That means the makeup is very similar — barring, of course, the ex-financials ETF that omits banks from its ranks.
However, the nice dividend yield and the more stable nature of these payers make dividend ETFs a good bedrock investment for most portfolios in these troubled times.
Jeff Reeves is editor of InvestorPlace.com. As of this writing, he did not own a position in any of the stocks named here. Follow him on Twitter via @JeffReevesIP and become a fan of InvestorPlace on Facebook.