ETFs: Niche Market to Supermarket

I'm not going to bore you with yet another article about the virtues of ETFs compared with those of ordinary mutual funds.

Yes, they're flexible and more efficient -- but you already knew that.

There is other news, too. ETFs proliferated like weeds in 2006, with some 144 new funds added -- an almost 50% increase, according to Morgan Stanley.

ETFs now handle some $450 billion in investor assets, and while coming on strong, they are still but a small part of the $10 trillion investment-company industry. But that news falls short of a full story as well.

However, as I looked at the 2006 arrivals more closely, it dawned on me that the real story lies in the growing sophistication of ETFs and new investor choices that result. ETFs are rolling out with more specialized and strategic designs as they sail beyond their index-fund roots toward the horizon of true active management.

Here are four evolving ETF types you should know about:

• Niche Industry

  Until recently, ETFs only gave the ability to buy an industry or sector as defined by broad S&P or Dow Jones sector indices, such as technology, consumer cyclical, energy or biotechnology. You were out of luck if you were interested in Canadian oil sands energy exploration, but now there's the Canadian Oil Sands ETF. If you think water is the next oil, you can check out the PowerShares Water Resources Portfolio (PHO).

• Currency

  For a pure play on the dollar vs. other currencies, you formerly had to trade currencies or currency futures directly or buy an international index ETF based on ADRs of international stocks -- at best, an indirect play.

  Now, new ETFs such as the Rydex Currency Shares Euro Trust (FXE) allow direct euro bets in what is effectively an international money-market fund -- you get interest that more or less pays the 40-basis-point management fee. It's a pure euro play and can be shorted or bought on margin as other ETFs can. Other family funds cover the Canadian dollar, Mexican peso and British pound.

• Commodity

  The streetTracks Gold Shares (GLD) arrived two years ago, set at one-tenth the price of gold and allowing investors to invest more or less directly in that commodity. The United States Oil Fund (USO) and the boldly named Claymore Macro Shares Oil Up Tradeable Shares (UCR) also track oil and oil futures.

  If you view real estate as a commodity, more REIT funds are coming on line, including a few, such as the streetTracks Wilshire International Real Estate ETF (RWX), tracking foreign real estate.

• Strategy

  Most exciting to me is a new breed of funds designed to follow specific investing strategies. Contrarian investors preferring companies with little analyst coverage, or stocks bought by insiders, now have ETFs available, thanks to Claymore Securities. These new ETFs follow indices specially crafted around specific strategies.

  ProShares offers a series of ETFs specializing in short-selling indices. Another set of market index funds called WisdomTree, created by market guru Jeremy Siegel, follows indices crafted to weight stocks by dividend payments, not market capitalization. The Powershares Buyback Achievers (PKW) is a collection of companies buying back at least 5% of their shares in the last 12 months. You get the idea.

Click here for the video version of this story from Jennifer Openshaw.