Editor’s Note: I’ve recommended a few exchange-traded funds (ETF) in the Silk Road Investor to gain access to Vietnam and other frontier markets, but this asset class has a lot to offer savvy investors. Benjamin Shepherd, editor of Louis Rukeyser’s Mutual Funds, and I will be hosting a conference call an exclusive conference call briefing on March 17 at 1:00 pm EST to discuss the wide world of ETFs. Registration is limited. Click here to sign up. To whet your whistle, here’s an article that Mr. Shepherd recently penned on the topic.

What to Buy with ETFs

By Benjamin Shepherd

Since Standard & Poor’s Depositary Receipts (NYSE: SPY) hit the American Stock Exchange in 1993, the universe of exchange-traded funds (ETF) has exploded.

Although open-end mutual funds still vastly outnumber ETF, if current trends continue ETFs could overtake mutual funds in terms of assets under management (AUM) by the end of this decade.

This might prove an overly optimistic assessment, particularly because mutual funds remain the primary options available to those investing through 401k plans. Even though the public may not be aware of them, there’s little doubt about ETFs’ utility.

True to their roots, most ETFs passively track an underlying index such as the S&P 500 or the Russell 2000. But about 10 years ago asset managers began creating custom indexes that have evolved to track almost every asset class, a multitude of industries and various sub-markets in almost every market in the world.

And last year the next frontier was opened when the US Securities and Exchange Commission agreed to allow the first actively managed ETFs to come to market.

The development of the ETF market benefits individual investors because these funds carry lower price tags and allow greater flexibility. Open-end index mutual funds typically bear expense ratios in the neighborhood of 1 percent to pay for back-office operations, managers and a network of distributors.

An ETF tracking the same index typically charges a third of that; ETFs rarely have fund-specific management teams and don’t require sales forces to distribute them.

With these attributes, ETFs make it possible for investors to track many of the trends and investment ideas covered in these pages, with built-in diversification and extremely low costs.

Offering impressive yields and solid business prospects, Canadian income trusts have long been favorites of my colleague Roger Conrad, editor of Canadian Edge. Claymore/SWM Canadian Energy Income (NYSE: ENY) typically holds a collection of about 30 Canada-based oil and gas outfits.

As of the end of the third quarter of 2009 that list stands at 24 and includes top names like Enerplus Resources (TSX: ERF-U, NYSE: ERF) and Vermilion Energy Trust (TSX: VET-U, OTC: VETMF).

Because of a new interpretation of Canadian tax law that took effect with ratification of the Fifth Protocol to the US-Canada Income Tax Convention on Dec. 15, 2008, US investors should no longer be subject to 15 percent Canadian withholding on distributions paid by Canadian companies in respect of shares held in a tax-advantaged account.

When held in a taxable account, Claymore/SWM Canadian Energy Income sidesteps taxation issues related to income trusts because it issues a 1099. Be sure, however, to consult your tax professional regarding any issue about cross-border taxation.

Potable water is becoming an increasingly scarce resource. But global governments are spending huge sums to prevent a looming hydration disaster. Based on current estimates, the US alone will spend almost $340 billion during the next 10 years to upgrade aging infrastructure and mitigate contamination.

And Booz Allen Hamilton forecasts that by 2020 only a third of all water pipes in the US will be rated in “excellent” condition, while 45 percent will fall into the “poor” or “very poor” categories.

Considering the state of the water infrastructure in the US, it’s no surprise that global water infrastructure spending is expected to top $22 trillion from 2005 to 2030. With almost $1 trillion being spent annually around the world, profits should continue to pour in over the next decade and beyond.

PowerShares Global Water Portfolio (NYSE: PIO), which applies a modified equal-weight methodology to its 30 holdings, is positioned to harness that flow.

With assets spread across industrials that manufacture pumps, pipes and valves, utilities that distribute the water–and in some cases own the supply–and information technology outfits that produce high-tech meters and monitoring systems, PowerShares Global Water encompasses the entire industry worldwide.

Infrastructure is another global mega-trend. The economies of China and India continue to grow, all the while undergoing rapid urbanization. Existing infrastructure has been taxed mightily in both countries; burgeoning transport, power and other utilities require significant investment to keep pace with populations that are more mobile than ever.

These realities have pushed infrastructure spending estimates up from $1.25 trillion annually in 2007 to $2.25 trillion over the next three years. Merrill Lynch analysts forecast that China alone will spend around $725 billion annually, followed by Russia at $325 billion and India at $240 billion.

There are three infrastructure ETFs traded in the US; our favorite is iShares S&P Global Infrastructure (NYSE: IGF).

SPDR FTSE/Macquarie Global Infrastructure 100 (NYSE: GII) and iShares S&P Emerging Markets Infrastructure (NSDQ: EMIF) both place greater emphasis on emerging markets but suffer from extremely low trading volumes and wide bid-ask spreads, which can ratchet up costs. Although these funds hold more attractive names, they’re not worth the cost.

iShares S&P Global Infrastructure holds a nice mix of US and European firms that offer some of the best infrastructure development expertise as well as a variety of global utilities and energy outfits.

Using a capitalization-weighted index, the fund is heavy on utilities such as E.ON AG (OTC: EONGY), Iberdrola SA (OTC: IBDRY) and RWE (OTC: RWEOY). Holdings also include several Macquarie subsidiaries and small positions in tanker MLPs.

Finally, materials firms will continue their recovery after being harshly punished in the recession. Commodity demand is a key driver, and huge imports of copper and coal have driven increases in spot prices, fueling a rally in materials stocks.

With stakes in miners such as BHP Billiton (NYSE: BHP) and Rio Tinto (NYSE: RTP), steel producers such as Posco (NYSE: PKX) and fertilizer giant Potash Corp of Saskatchewan (NYSE: POT), iShares S&P Global Materials (NYSE: MXI) offers exposure to the gamut of materials companies. Also employing a capitalization-weighted index, the ETF favors the larger operators. It also experiences surprisingly low volatility.

iShares S&P Global Infrastructure and iShares S&P Global Materials are buys under 38 and 70, respectively.

Benjamin Shepherd is editor of Louis Rukeyser’s Wall Street and Louis Rukeyser’s Mutual Funds. He and Yiannis Mostrous will be conducting a teleconference on using ETFs to enhance portfolio performance on March 17 at 1:00 pm EST.