When you think of chemical stocks, is the first thought to cross your mind the chemistry set you had when you were a child? Until I began looking deeper into the stocks that make up the chemical industry those were my initial impressions. Now that I realize the diversity and potential within the industry my mind is full of possible investment ideas.

How To Invest In Chemical Stocks
The chemical industry is made up of four sectors and is quite diverse. The four sectors making up the industry are agricultural chemicals, specialty chemicals, major diversified chemicals and synthetics. All four are outpacing the S&P 500 year-to-date with the synthetics rallying nearly 15%. To gain exposure to the entire industry it would take a number of investments in each sector. Because most investors have a limited amount of cash that is not a possibility.

The alternative is to look for an investment vehicle that offers a basket of chemical stocks. Unfortunately there is not a chemical exchange-traded fund (ETF), but there are three ETFs that come very close. All three are considered material ETFs, but in reality they are made up of 50% chemical stocks. Below is an analysis of the three ETFs that can be used to gain exposure to the booming chemical sector. (To learn more, see Introduction To Exchange-Traded Funds and How To Use ETFs In Your Portfolio.)

Three Chemical ETFs
The SPDR Materials ETF
(AMEX:XLB) is composed of 29 stocks with 50% of them falling into the chemical sector. The top five holdings in order are DuPont de Nemours (NYSE: DD), Dow Chemical (NYSE: DOW), Monsanto (NYSE: MON), Alcoa (NYSE: AA) and Freeport McMoran Copper & Gold (NYSE: FCX). Due to the limited number of holdings, the top five make up 45% of the allocation, which increases the risk slightly. The expense ratio is a very reasonable 0.24% and the ETF pays a dividend of 2% annually. Year-to-date the ETF is up over 13%, doubling the return of the S&P 500 (5.2%).

The second ETF the Dow Jones US Basic Materials ETF (NYSE: IYM) happens to have the same top five as XLB. The major difference is the number of stocks that make up the ETF. IYM is composed of 76 stocks, nearly three-times that of XLB. The percentage in the top five is also lower with only 35% of the allocation. The greater diversity lowers the risk level of this ETF. Also its expense ratio is a higher 0.48% and the dividend yield is 1.1%.

Third on the list of ETFs is the Vanguard Materials ETF (AMEX:VAW). Again the top five are identical to the other two; the variation is the number of assets. The top five make up only 30% of the holdings. With even more diversity, VAW would be considered the least risky of the group. A low expense ratio of 0.25% is attractive, and investors will receive a minimal dividend of 1.4%.

The Winner Is
After reading the synopsis of the three ETFs it's near impossible to differentiate between them. This is when I turned to past performance. Year-to-date VAW has the edge with a gain of 15.8%, triple that of the S&P 500. In 2006 VAW was again the leader, gaining 17.6% versus XLB with 16% and IYM 14.6%. Going back to 2005, all three were within 1% of each other. Therefore, based on past performance, which is no guarantee of future performance, VAW has the slight edge.

When expense ratio and reward-to-risk are added to the equation, again VAW comes out on top. Vanguard is known throughout the industry for its low expenses and VAW falls into the category of below-average expense ratio. The fact VAW has the lowest percentage of assets in its top five is attractive because it lowers risk with added diversity.

If I had to choose one of the three ETFs, the clear winner is VAW.

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Tickers in this Article: XLB, VAW, IYM, DD, DOW

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