3 Quirky ETFs Are Beating the Market

The universe of exchange-traded funds is crowded with investments you don't need. Most of this dead timber is based on investing gimmickry or follows an absurdly narrow focus. Case in point: Airshares EU Carbon Allowances Fund, a short-lived critter 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 down the fund.

But that's no reason to ignore a quirky ETF that shows promise. And 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 leads the group, with a 35% gain year-to-date through August 3, compared with a 13% return for the S&P 500. The fund tracks a benchmark, dreamed up by Beacon Indexes, that follows companies that were spun off from six months to two years before the ETF's semiannual rebalancing date (the minimum waiting period of six months allows some of the initial share-price volatility following a spinoff to die down). Beacon will pare the list to 40 names if more than 40 stocks are eligible for inclusion.

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The gimmick works because managements of jettisoned companies need to work hard to thrive, perhaps even to survive. "These companies tend to be more efficient, more focused and more independent than their parent companies," says Christian Magoon, president of Claymore Securities. The ETF's 29% weighting in technology stocks, which have performed particularly well during the rally, hasn't hurt results this year.

The Claymore/Sabrient Insider ETF clocks in second, with a year-to-date gain of 26%. The index that the fund tracks seeks out companies for which analysts recently upgraded their earnings estimates and whose insiders (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 78% of its assets in small-capitalization stocks. That's certainly helped performance lately compared with large-cap indexes, such as the S&P 500, but its 2009 returns also look good next to the 13% advance of the Russell 2000 index, which tracks small-company stocks.

The broadly diversified PowerShares Buyback Achievers fund gained 15% 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 its annual reconstitution. The fund isn't heavy on any one segment of the market, and it spreads assets among some 340 issues, so its market-beating returns look to be the result of good stock selection.

Still, investors shouldn't assume these funds have discovered the Holy Grail of stock picking. None of the funds is yet three years old, and the Insider fund is the only one that is beating the indexes over its lifetime-from its September 2006 inception through August 3, the fund lost an annualized 1%, while the S&P 500 and the Russell 2000 both shed 7% annualized.

Moreover, ETF investors need to guard against more than just bad performance. Industry watcher Ron Rowland publishes on his Web site (www.investwithanedge.com) a monthly "ETF Deathwatch" list of funds with little to no trading volume. The Spin-Off fund is on the latest list, while the Buyback Achievers fund, he says, "narrowly escaped" inclusion.

His concern is that Claymore and PowerShares could shutter their 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 could mean that the funds' "trading prices may not be tracing their underlying value very closely."

Rowland speculates, however, that the funds are so close to their third birthdays -- at which point they will be eligible for Morningstar's star ratings -- that Claymore and PowerShares will keep them alive for now on the hope that they will receive four- or five-star ratings. Once a fund receives a good rating from Morningstar, "assets automatically start flowing in," he says. The Insider fund will turn three in September, while the other two funds will do so in December.

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