Lower oil prices may have been good news for your wallet but they wreaked havoc on the energy markets. If you are looking to allocated some of your portfolio to energy in preparation for a possible market rebound, here's are the different kinds of funds you could consider.
Exchange-traded funds, or ETFs, have become a widely popular investment vehicle and compete with traditional mutual funds. ETFs have a number of advantages over mutual funds, such as charging lower expense ratios, and trade throughout the day in the same way an individual stock trades on the stock market. In contrast, mutual funds can only be redeemed at the net asset value price at the end of the day after all of the individual holdings can be priced and aggregated into a daily fund quote.
These general differences are important to consider when investing in the energy industry. Below is an overview of some more prominent energy funds and ETF options available to individual investors.
An energy ETF is likely one of the most convenient and quickest ways to gain exposure to a sector-specific index. You could invest in companies that are in the energy business through ETFs such as Energy Select Sector SPDR® ETF (NYSEARCA:XLE) or you could also consider investing in an ETF that has exposure to the actual physical commodity like the United States Brent Oil fund ETF (NYSEARCA:BNO). Certain funds such as Global X MLP (NYSEARCA:MLPA) that invest in energy master limited partnerships have a reputation for paying out appealing dividends, though tax implications can be complicated.
The expense ratios for such funds are generally reasonable and below 1%. The most expensive of the lot are the ETFs with direct commodity exposure that have average expenses of around, 0.9%. Equity energy ETFs have average expenses of close to 0.5%, with Vanguard Energy ETF (VDE) that has expenses of 0.1% among the lowest with an expense ration of 0.1%.
Energy Mutual Funds
Mutual fund rating firm Morningstar lists in excess of 100 energy mutual funds. As of October 31st, 2016, the return for the equity energy category stood at 14.75% while the three-year return was a negative -12.26%. Funds investing in energy MLPs also also picked up with a year-to-date performance of 17.89% as compared to a -5.53% three-year return.
Given the many different offerings, nearly any strategy, be it bearish or bullish on the energy sector, can be employed. There are opportunities to gain exposure to varying market capitalizations, whether it's small, mid or large cap. One can also aim for growth companies, or simply those that pay above average dividend yields.
Another popular strategy is alternative energy, as are those that invest in large capitalization energy names or in basic natural resources and basic material commodities.
The Bottom Line
An energy ETF likely represents the most efficient way to gain exposure to the energy sector. The choices trade throughout the day and generally charge reasonable fees. Investors seeking more specific, active strategies may be interested in the wide array of energy mutual funds. Energy index mutual funds may also have appeal because each security is actually held. For less liquid ETF strategies, be sure to read the prospectus to determine how investment strategies are carried out and if the actual securities are held in the portfolio.