Standout Specialty ETFs

12/02/2013 8:00 am EST

Focus: STOCKS

Richard Moroney

Editor, Dow Theory Forecasts

Although a lot of new exchange-traded funds are gimmicky—tracking obscure indexes or unproven strategies—not all specialty funds should be avoided, suggests Richard Moroney, editor of Dow Theory Forecasts.

Some ETFs can help investors diversify a portfolio and make bets on a particular strategy, industry, or asset class. Below, we highlight several standouts among niche ETFs.

Income picks

Preferred stocks offer high yields, but they behave more like bonds than stocks, with prices sensitive to interest rates and a company's creditworthiness. A solid pick is iShares US Preferred Stock (PFF), which yields 6.5%.

Master limited partnerships, which often invest in energy pipelines, do not pay taxes at the corporate level, allowing for outsized dividends. Most MLP funds are structured as ETNs, but one ETF worth a look is ALPS Alerian MLP (AMLP), which yields 5.9%.

Bond picks

High-yield bond funds are the best-performing bond category so far, this year. The funds, which hold mostly lower-quality corporate bonds, are generally more sensitive than other bonds to the outlook for the economy.

SPDR Barclays Short-Term High Yield Bond (SJNK), which holds bonds with maturities of less than four years, yields an attractive 4.0%.

Stock picks

Many of today's top-performing stocks are the very smallest companies—the kind you find in micro-cap funds.

Micro-cap ETFs, which typically focus on stocks with market values below $500 million, can be volatile, but represent a nice diversifier for most portfolios. Up 35% this year, iShares Micro-Cap (IWC) is worth consideration.

Sector-specific ETFs offer the potential for outsized returns—and risks—because of their narrow focus. Still, if you have strong feelings about a particular sector and understand the risks, sector funds can be a good niche investment.

To uncover top picks, we looked for solid track records and reasonable expense ratios. Notable ETFs include SPDR S&P Oil & Gas Exploration & Production (XOP), Guggenheim S&P 500 Technology (BATS:RYT), and SPDR S&P Retail ETF (XRT).

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