Top Three ETFs for 2010

NEW YORK ( TheStreet) -- In 2009, investors in exchange-traded funds flocked to alternative assets, emerging markets and bonds.

The SPDR Gold Shares ETF ( GLD) and Vanguard MSCI Emerging Markets ETF ( VWO) both had net asset inflows of more than $1 billion.

Bond funds like iShares' TIPS ETF ( TIP) and Investment Grade Corporate Bond ETF ( LQD) ranked among the largest funds in the ETF universe.

In the wake of the global economic crisis, some investors regained their appetite for risk, while others sought protection from it.

As 2010 begins, a different group of market forces, political pressures and investor frustrations will guide the flow of ETF assets and help to shape the future of the fund industry. ETFs, with their unique structure and low management costs, will continue to offer investors convenient ways to access individual sectors, market trends and portfolio strategies.

While many of the concerns that inspired investors in 2009 will still affect investing in the months ahead, ETF investors should consider the three following themes, and their corresponding funds, as they prepare their portfolios for 2010:

Dividends: iShares Dow Jones Select Dividend Index ETF ( DVY)

With rates pegged near zero for the foreseeable future, investors will have to venture out of bond and money market funds and into equities to find returns. High-yield dividend stocks are attractive holdings for investors looking to step off the sidelines and put their money to work.

ETFs like DVY are a good way to gain exposure to high-yielding equities while minimizing security-specific risk.

DVY's strategy is to identify companies with the highest-paying dividends, and then eliminate the riskiest holdings with a series of "screens." In an effort to avoid exposure to extremely distressed firms, DVY's index omits REITs, as well as firms that have paid more than 60% of earnings in the form of dividends or cut their dividend in the past five years.

DVY is a large, liquid ETF with top holdings that currently include Chevron ( CVX), Kimberly-Clark ( KMB) and McDonald's ( MCD). The top sector allocations in DVY's portfolio are utilities, consumer goods and industrials, with 26.56%, 18.55% and 14.97% allocations, respectively.

Inflation Protection: iShares Barclays TIPS Bond ( TIP)

Low interest rates, a weak dollar and massive stimulus spending will continue to keep talk of both inflation and deflation in the headlines in 2010. While hard economic data has yet to demonstrate a real inflation threat, it makes sense to include inflation protection in your portfolio, and to do so before periods of high inflation.

Buying shares of an ETF like TIP, which tracks a portfolio of Treasury Inflation Protected Securities (TIPS), is an easy and inexpensive way to protect against inflation in a diversified portfolio. TIP has the advantage of being the first mover in the TIPS ETF space, and this ETF has a laddered structure to provide exposure to securities with different maturities.

According to recent data from the National Stock Exchange, TIP is the sixth largest fund in the ETF universe when measured by assets. TIP experienced an incredible expansion in 2009, and government initiatives, coupled with investor fears, should help to keep this fund at the top of the pack in 2010.

Green Energy: PowerShares WilderHill Clean Energy ( PBW)

Science has yet to come to a consensus on global warming, but two hard facts will keep "green energy" a hot topic in 2010. First, the rapid expansion of emerging markets and limited natural resources have helped to put a premium on the development of green energy technology. Secondly, both legislation and regulation are working to curb carbon emissions in both the U.S. and abroad. (See "Five Energy ETFs to Watch".)

PBW is designed to deliver capital appreciation through exposure to companies that focus on greener and generally renewable sources of energy and technologies that facilitate cleaner energy. This large, liquid ETF tracks 52 firms, including JA Solar Holdings ( JASO), Fuel Systems Solutions ( FSYS) and Advanced Battery Technologies ( ABAT).

Cleaner energy and the reduction of carbon emissions will be top items on the political agenda in 2010. As companies work to comply with new standards, investors in PBW will already be ahead of the curve. (See "ETF Plays for Copenhagen Talks".)

ETFs are an easy, inexpensive way to gain access to short-term market trends and diversify a long-term portfolio. As investors move assets into segments of the market like clean energy, inflation protected securities and high-yielding equities, the rapidly expanding ETF marketplace will evolve to meet their changing needs.

Inflation concerns fueled the recent launch of three additional TIPS ETFs by bond giant PIMCO, while the buzz over renewable energy has produced increasingly focused green ETFs.

Investors looking to participate in these areas of the market should aim for ETFs with high liquidity and low expense ratios. (See "Tips for Trading ETFs".)

DVY, TIP and PBW are good funds to target in 2010.

-- Written by Don Dion in Williamstown, Mass.

At the time of publication, Dion owned DVY and TIP.

Don Dion is president and founder of Dion Money Management, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years' experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.

Dion also is publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.

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