3 Quirky ETFs Beat the Market

The world of exchange-traded funds is crowded with investments you don't need. Most of this dead timber relies on investing gimmickry or has an absurdly narrow focus. Case in point: AirShares EU Carbon Allowances Fund, a short-lived ETF that tracked the prices of futures contracts on carbon allowances created by Europe's cap-and-trade system for controlling pollution. Thankfully, this dud's sponsor recently shut it down.

But some quirky ETFs show promise. Three funds that follow sound, if narrow, investing strategies are trouncing Standard & Poor's 500-stock index so far this year: Claymore/Beacon Spin-Off (symbol CSD), Claymore/Sabrient Insider (NFO) and PowerShares Buyback Achievers (PKW).

The spinoff fund led the group, gaining 40% year-to-date through September 4, compared with a 15% return for the S&P 500. The fund tracks a Beacon Indexes benchmark that follows 40 companies that have been spun off recently from their parent firms.

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Investing in spinoffs is a sound strategy because managers of jettisoned companies need to work hard to thrive. "These companies tend to be more efficient, more focused and more independent than their parent companies," says Christian Magoon, president of Claymore Securities. At last report, the ETF had 29% of its assets in technology stocks.

The Insider ETF has earned 32% so far in 2009. The fund tracks an index of companies whose earnings estimates have recently been increased and whose top executives and directors have been buying stock on the open market. "There are a lot of reasons why insiders sell, but there's really only one reason why they buy," Magoon says.

Because the fund weights each of its 100 holdings equally, rather than by market capitalization, it's biased toward smaller companies; it recently stashed 77% of its assets in small-cap stocks. That's certainly helped performance lately compared with large-cap indexes, such as the S&P 500, but the ETF's 2009 returns also look good next to the 15% advance of the Russell 2000 index, which tracks small-company stocks.

The broadly diversified PowerShares Buyback Achievers fund gained 20% year-to-date. It invests in companies that have repurchased at least 5% of their outstanding shares (after factoring in issuance of new shares and stock-option compensation) over the 12 months leading up to the ETF's annual reconstitution. The fund is well diversified among sectors, and it holds about 330 stocks.

Still, investors shouldn't assume these funds have discovered the holy grail of stock picking. The funds are just rounding their third birthdays, and only the Insider fund is beating its index over its lifetime -- from its September 2006 inception through September 4, the fund lost an annualized 1%, while the S&P 500 and the Russell 2000 shed 6% and 7% annualized, respectively.

Moreover, ETF investors need to guard against more than just bad performance. Industry watcher Ron Rowland publishes "ETF Deathwatch," a monthly list of funds with little to no trading volume (www.investwithanedge.com), and both the Spin-Off and the Buyback Achievers funds are on the latest list.

Rowland's concern is that Claymore and PowerShares could shutter the tiny funds, which likely aren't making a profit for the firms. Such a closing could trigger unwanted transaction costs and tax implications for investors. Plus, Rowland says, an absence of trading volume implies that the funds' "prices may not be tracking their underlying value very closely."

You should give these funds more time to prove themselves, and collect assets, before you consider investing. But it's some comfort to know that not every quirky ETF has been a bust from the get-go.

Editor's note: This story originally appeared on the Web as a Fund Watch August 4, 2009.

Elizabeth Leary (née Ody) first joined Kiplinger in 2006 as a reporter, and has held various positions on staff and as a contributor in the years since. Her writing has also appeared in Barron's, BloombergBusinessweek, The Washington Post and other outlets.