After enduring the ups and downs of 2010, exchange-traded fund (ETF) investors were hoping to end the year in the black. The market cooperated as the number of positive-performing ETFs, 68, far outstripped the eight funds that had negative performance numbers, according to available Morningstar data, through Nov. 30, 2010.

By early December, overall year-to-date ETF net assets stood at $40 billion. This represented a 27.5% gain, or $8.6 billion of new assets flowing into ETFs, according to the most recent data on money flows from Select Sector SPDRs.

The best-performing sectors generally followed the script of an economic recovery too. According to Select Sector SPDRs, the consumer discretionary category was up 26.3%, industrials were up 23.4% and energy was up 16.1% year to date, through Dec. 7. "It was just a classic recovery, when you look at what was going on in the market," says Dan Dolan, director of wealth management strategies for Select Sector SPDRs. "Economically sensitive sectors took the lead."

 

CAUTION ON THE TRACKS

The technology sector, surprisingly, did not join its higher-performing peers, Dolan says. That category posted a positive year-to-date number, up 8.9%, and it was up almost 15% over the last three months, but technology ETFs experienced two major periods of volatility throughout the year, including a very bumpy summer.

Traditionally defensive sectors, such as healthcare and utilities, did not end the year well. Healthcare was down 0.3%, and utilities gained just 0.5%, as investors shifted money to support other sectors.

Dolan says it was no surprise that healthcare ETFs did not share in the year-to-date upswing, given the continuing uncertainty in the sector. Utilities should have done better, however, because that group of funds offers a dividend yield of about 4.07%, the highest among ETFs. If President Barack Obama and Republican lawmakers decide to keep the dividend tax at 15% instead of the higher ordinary income rate, that might make the sector more attractive to investors, Dolan says. The measure had not been finalized at press time.

 

FOREIGN UNCERTAINTY

Even ETFs linked to foreign stocks lost some of their luster. Predictably, equity ETFs indexed to European stocks were down 3.6%, as the European Union approved an $89 billion bailout for the Irish banking system and rumors of a similar remedy for Portugal began circulating.

Emerging-market bond ETFs were one bright spot among global ETF bets, however. That group was up 12.6%, and the Wisdom Tree Emerging Market Local Debt Fund (ELD), capitalized on the category's popularity. Launched in early August, the fund has already accumulated $374 million in assets under management.

"One of the hottest areas out there is emerging-market debt," explains John Gabriel, an ETF analyst at Chicago-based Morningstar. "Global debt is generally looking to diversify away from the U.S. dollar."

Although ETFs exhibited signs of a broad-based recovery, analysts and investors alike expressed caution. In early December, unemployment remained high, at 9.8%. If that keeps up, says Dolan, it could endanger the consumer discretionary category's healthy performance. For their part, investors continue to embrace fixed-income investments. High-yield bonds fared especially well, up 9.8% year to date.