Exchange-traded funds enable investors to reach into nearly every corner of the market with a single convenient and diversified U.S.-traded security. Energy equities represent one of these corners of the market, where it’s important to remain diversified given the volatility present in many of the underlying commodities moving the market. Fortunately, there are many ETFs that are uniquely suited to help investors build exposure into their portfolios .
What’s The Appeal?
The energy sector represents an extremely important portion of the U.S. economy, particularly as the U.S. is the second largest energy consumer in the world behind China. For investors, the boom in hydraulic fracturing has also brought a lot of attention to the industry, with the potential for the U.S. to become energy independent by 2030 and export oil abroad by the year 2035, according to the U.S. Energy Information Administration (“EIA”).
Investors seeking exposure to this sector may find that ETFs offer key advantages over purchasing equities individually. In addition to the benefits of diversification, ETFs provide investors with greater liquidity than may be possible in many smaller energy equities, including many American Depository Receipts (“ADRs”) traded on U.S. exchanges. These ETFs also target a broad array of equities, making it possible to invest in many corners of the energy market .
Watch Your Big Oil Weight
The problem with many energy ETFs is that they are weighted based on market capitalization, which means that large oil companies often account for an oversized portion of overall holdings. For example, the Energy Select Sector SPDR holds roughly 17% of its portfolio in Exxon Mobil (XOM) and 15% of its portfolio in Chevron (CVX). These oversized holdings add company-specific risk and overweight exposure to big oil to an individual’s overall portfolio.
Investors looking to avoid this type of exposure can purchase ETFs that utilize different stock selection methodologies. For example, the First Trust Energy AlphaDEX Fund ETF selects energy stocks from the Russell 1000 Index based on growth factors, like stock price appreciation, price-to-sales ratios, and one-year sales growth. While these may not be weighted according to market capitalization, they may be far more diversified than other options .
Here’s a comparison between some various energy ETF options (data as of 10/30/13):
|Ticker Symbol||ETF Name||Largest Allocation (%)|
|XLE||Energy Select Sector SPDR||Exxon Mobil (17%)|
|VDE||Vanguard Energy ETF||Exxon Mobil (22%)|
|PXI||PowerShares Dynamic Energy Sector ETF||Noble Energy (2.7%)|
|RYE||Rydex S&P Equal Weight Energy ETF||Newfield Exploration Company (2.5%)|
Going Beyond Oil
Crude oil represents the largest portion of the energy market, which means that many energy ETFs are dominated by oil-related stocks. Investors looking for exposure elsewhere in the energy market have numerous options in solar energy, wind energy, natural gas, or coal, as well as equipment and service companies that aren’t necessarily tied to the price of oil, including engineering and consulting firms that act as advisors or suppliers to the industry .
Some popular alternative energy ETFs include:
- PowerShares WilderHill Clean Energy ETF – With $217 million in total assets and a 0.7% expense ratio, the ETF invests in companies that focus on greener and generally renewable sources of energy and technologies that facilitate cleaner energy.
- Market Vectors Oil Services ETF – With $1.7 billion in total assets and a 0.35% expense ratio, the ETF invests in the 25 largest U.S.-listed, publicly traded oil services companies, including names like Halliburton Co. (HAL).
- Market Vectors Global Coal ETF – With $176 million in total assets and a 0.59% expense ratio, the ETF invests in companies within the coal industry, including names like Joy Global Inc. (JOYG) and Consol Energy Inc. (CNX).
- First Trust ISE-Revere Natural Gas Index ETF – With $540 million in total assets and a 0.6% expense ratio, the ETF invests in natural gas stocks, including names like Noble Energy (NBL) and Goodrich Petroleum Corp (GDP).
Investors in the energy sector may also want to diversify their exposure around the world, instead of focusing exclusively on the United States. While energy is largely a global commodity, U.S. based firms can be affected by a number of domestic-only issues, including increased governmental regulation, tariffs, or other risk factors. Diversifying internationally can help allay many of these concerns and improve risk-adjusted returns across the board .
Some popular global energy ETFs include:
- iShares S&P Global Energy Sector ETF – With $993 million in total assets and a 0.48% expense ratio, the ETF invests in energy companies around the world with only about 50% weighting in the U.S. and about 15% exposure to Exxon Mobil (XOM).
- SPDR S&P International Energy Sector ETF – With $13 million in total assets and a 0.5% expense ratio, the ETF invests in non-U.S. energy companies, including names like BP plc (BP), where it holds about 11% of its total value.
The Bottom Line
Investors have many options when it comes to investing in energy ETFs, but the four considerations in this article should help narrow the field. By being mindful of weightings and expense ratios, investors can avoid unexpected problems, while considering alternative sub-sectors and international companies can help improve diversification.
Disclosure: No positions at time of writing.
Mutual Funds & ETFsLearn about the iShares JPMorgan USD Emerging Markets Bond fund, which invests in bonds of sovereign and quasi-sovereign entities from emerging markets.
Mutual Funds & ETFsLearn how the SPDR Dow Jones International Real Estate exchange-traded fund (ETF) is managed and for whom the ETF is most appropriate.
Active Trading FundamentalsUnderstand what front running is, and learn how hedge funds use this investing strategy to profit from the anticipated stock buys of index funds.
Mutual Funds & ETFsDiscover how the Schwab U.S. Large-Cap exchange-traded fund is managed, the index it tracks and the investors for which it is most appropriate.
Mutual Funds & ETFsLearn more about the Rogers International Commodity Total Return, which is an exchange-traded note that tracks a broad index of commodity futures.
Mutual Funds & ETFsObtain information about an ETF offerings that provides leveraged exposure to the biotechnology industry, the ProShares UltraPro Nasdaq Biotech Fund.
Mutual Funds & ETFsLearn about the iShares MSCI Europe Financials fund, which invests in numerous European financial industries, such as banks, insurance and real estate.
Mutual Funds & ETFsLearn about the SPDR S&P Insurance exchange-traded fund, which follows the S&P Insurance Select Industry Index by investing in equities of U.S. insurers.
Mutual Funds & ETFsLearn about the SPDR S&P Emerging Markets Small Cap exchange-traded fund, which invests in small-cap firms traded at the emerging equity markets.
Mutual Funds & ETFsLearn about the physical platinum ETF. Platinum embarked on a bull market from 2001 to 2011, climbing to record prices along with other precious metals.
A security that tracks an index, a commodity or a basket of assets ...
Investopedia explains the definition of exchange-traded mutual ...
An alternative investment theory to Efficient Market Hypothesis ...
A nickname given to Africa's growing economies.
An investment strategy in which securities are chosen based on ...
Exchange traded funds that are designed to trade in a direction ...
If an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over a one-year period. ... Read Full Answer >>
The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>
Asset management utilizes two main investment strategies that can be used to generate returns: active asset management and ... Read Full Answer >>
Wash trading, the intentional practice of manipulating a stock's activity level to deceive other investors, is not a legal ... Read Full Answer >>
There are many exchange-traded funds (ETFs) that track the retail sector or elements of the retail sector, and some of those ... Read Full Answer >>
Some of the most popular exchange-traded funds (ETFs) that track the retail sector include the iShares S&P Global Consumer ... Read Full Answer >>