With the major market averages up about 10-15% thus far in 2012, it goes without saying that many exchange-traded funds (ETFs) have risen by a similar amount. But a handful of ETFs have had a banner year, rising at a much faster clip. The biggest gainers: ETFs that focus on home builders, biotechnology and financial services stocks.
The Year's Top-Performing Equity ETFs
The key question: Are these moves part of a multi-year uptrend or are these funds ripe for a pullback?
Well, when it comes to home builders, caution certainly appears warranted. New-home construction figures have surely been impressive, but the whole housing market is still on tenuous footing, so 2012's gain may have already accounted for any more good news to come in 2013. Then again, economic growth in 2013 may be so tepid, that these recent strong gainers rotate right back out of favor, as I mentioned nearly two months ago.
The outlook for biotechnology is more durable, as sales and profits can grow in any economic climate. Yet these biotech-focused ETFs have been posting solid gains for several years, and considering the ever-present business risk for the industry's key players, it's always wiser to load up on biotechs when they are out of favor.
It may seem odd to find a group of banking-oriented ETFs among the year's top gainers. After all, most banks are still generating profit margins well below recent peaks. And the regulatory environment is only getting stiffer in the years ahead. Yet many banks were so remarkably cheap -- in the context of book value -- that they've had nowhere to go but up. Take Citigroup (NYSE: C) as an example. Even after a strong spurt, shares still trade well below book -- a 37% discount to book, to me more precise -- as I noted here.
The same logic applies to other banks stocks as well. By the time the economy is truly healthy -- perhaps in a few years -- then these banking stocks may trade closer to 1.5 times book value (which is the historical industry average). This only means these rallying ETFs still have solid upside.
The BDC angle
Here at StreetAuthority, we're big fans of business development companies (BDCs). These firms take stakes in a range of start-ups and can harvest big gains if their seeds sprout into large enterprises. The PowerShares Global Listed Private Equity Portfolio (NYSE: PSP) takes the "fund of funds" approach, with stakes in a range of BDCs.
This fund, which was launched in late 2006, had an inauspicious debut, dropping roughly 80% from inception to early 2009. This was a reflection of the deep carnage that a weak economy can inflict on the valuations of young, unproven companies. But this ETF looks better positioned in the context of an improving economy, as small private companies tend to have an easier time lining up needed financing and are less likely to hit a big cash crunch.
This ETF has posted solid gains in 2012, and would likely move nicely higher if the economy can build a head of steam into mid-decade. As a minor turn-off, this ETF carries a mutual-fund like expense ratio of 2.37%, as its managers must actively manage the portfolio. So this is better-suited as a long-term investment than as a short-term trading vehicle.
The foreign ETFs
As we focus on the top-performing domestic equity ETFs, it also pays to see what's working outside our borders. China's impressive economic growth during the past decade continues to have beneficiary ripple effects across Asia. Hong Kong, Singapore and Thailand have all seen solid market gains this year, as their economies cultivate rising middle classes.
And it should come as no surprise that Turkey and Colombia remain top performers, thanks to their solid regional positioning and expanding middle classes. These two countries are among the CIVETS nations, which I first profiled here.
Risks to Consider: As they say, past performance is no guarantee of future performance, especially for the hottest ETFs such as the ones that focus on home builders.
Action to Take --> These ETFs are benefiting from powerful current trends, so you need to assess how those trends will likely play out in 2013 and 2014 to see how these surging ETFs are could fare. Only a handful look set to lead the pack again in 2013.