The 5 Best-Performing ETFs of 2011

Despite the recent bearish effort, the stock market‘s still up 6% for the year. Some sectors and groups, however, are up more than others. Such outperformance begs the question: are these leading industries already over-baked, or is their current leadership an omen of what’s to come?

Let’s first identify the top-performing exchange-traded funds (ETFs) for the year so far, and tackle the tougher questions after that.

2011’s year-to-date ETF winners
Just to clarify, leveraged funds have been removed this list of top performers, since they’re more for speculators and less for buy-and-hold investors.

1. B2B Internet HOLDRs (NYSE: BHH): Of all the names that made the cut, this one may also be the most surprising. ‘Business-to-business’ (a nickname for the corporate-level marketplace of goods, supplies, and services) stocks like Ariba (Nasdaq: ARBA) and Internet Capital Group (Nasdaq: ICGE) — the only two names the fund holds — never really hit their enthusiasm stride again after the 2001/2002 recession. But, something is clearly lighting a fire now.

#-ad_banner-#Note that owning the B2B Internet HOLDRs is essentially a play on Ariba, which makes up 90% of the fund’s allocation. That may not be a bad thing though, as the decision to convert its platform from software-based to cloud-based is one stop closer to the company’s goal of becoming a “Facebook for business.” With a forward-looking price-to-earnings ratio of 30.3 it’s a little heavy in terms of valuation, but if last quarter’s 41% increase in revenue is any indication, the company’s on the right track.

2. United States Brent Oil Fund (NYSE: BNO): Why has this oil fund performed better than, say the U.S. Oil Fund (NYSE: USO)? That’s because BNO is based on Brent futures, which are more popular in Europe and Asia, and more sensitive to the turmoil in the Middle East. USO is based on West Texas Intermediate oil futures, which have actually seen a bit of a delivery glut of late.

Either way, both funds are higher because oil prices have been rising, until recently. And, when oil swings, it tends to swing big. The Brent crude fund is down more than 12% for the month so far, with no help in sight.

3. Rydex S&P MidCap 400 Pure Growth (NYSE: RFG): This is nothing new — this cap/style group has been quietly leading the charge since the March-2009 bottom. Mid-sized companies have found a bit of a sweet spot in a moderate-growth environment. They’re more nimble than the slower-moving large caps that aren’t finding easy money in any longer, but better-funded and better-shielded than small caps. As long as economic mediocrity reigns, so too should the mid caps.  

As tempting as it may be to look for a stock within that group rather than buy the group itself, this is a case where the risk/reward scenario of casting a wide net approach may make more sense.

4. Semiconductor HOLDRs (NYSE: SMH): This shouldn’t be a surprise — economic recoveries tend to favor technology stocks, and the underlying names like Applied Materials (Nasdaq: AMAT) and Intel (Nasdaq: INTC) have the earnings growth to prove it (both are on pace for record-breaking income in 2011).

5. Pharmaceutical HOLDRs (NYSE: PPH): It’s been a bit of a perfect storm of late for the healthcare sector as a whole, and the pharmaceuticals industry in particular. Fears of what President Obama’s health care overhaul would mean for drug companies have been weighing on these names since 2010, but the sellers overshot their target. In the meantime, a slew of good news has been bolstered by the realization that the new era of healthcare won’t necessarily kill the pharmaceutical industry. Investors have started to warm-up to the group again.

There’s nothing inherently wrong with the underlying fundamentals of the pharmaceutical names. But the ETF boasts an average P/E of 14.1 and the move in these names has been a little overheated, as the pharmaceutical ETF is struggling to continue making gains after the 16% rally began two months ago. 

Action to Take –> Like the old adage says, past performance is no guarantee of future results. So, let’s not assume the next four months will be a repeat of the prior four. Indeed, for the pharmaceuticals fund as well as the U.S. Brent Oil Fund, it looks like the party’s over — at least for a while. Those two may be best left alone for now.

As for the Semiconductor HOLDRs ETF, the MidCap Growth Fund and the B2B Internet HOLDRs ETF though, the year-to-date leadership may indicate strong opportunity.

For reasons described above, the MidCap Growth Fund’s leadership is long, well-established and not likely to fade any time soon. Indeed, the group may well lead the way to the very end of this tepid cyclical bull market (whenever that is).

The Semiconductor HOLDRs ETF — in the shadow of a big run-up this year and a whopping 45% rally since August — still has room for more upside. The semiconductor group’s average trailing price-to-earnings (P/E) ratio is a mere 13.0, which is considerably cheaper than the S&P 500’s trailing P/E of 15.8. While a near-term blip may be in the cards, there’s another 30% to 35% worth of potential longer-term gains still packed into the fund.

P.S. — Few investors realize that a 20-year energy agreement between the United States and Russia is about to expire. This deal supplies 10% of America’s electricity. As broke as our government is, the situation is so serious that President Obama is asking for $36 billion to avert this crisis. And Republicans support him. Here’s what’s going on…