An energy exchange-traded fund (ETF) is a hybrid equity instrument that focuses on the securities of oil, natural gas and alternative energy companies. The underlying securities in an energy ETF can include an entire sector index, domestic or foreign energy producers, energy equipment manufacturers or specific subsectors, such as coal, oil or alternative energy.
Energy ETFs cover a variety of business types, regions and risk profiles. Since the energy sector is such a large part of the global economy, nearly every investor with a balanced portfolio has some kind of exposure to energy companies.
Vanguard Energy ETF
One of the largest and lowest expense energy ETFs is Vanguard's Energy ETF (VDE). Like all Vanguard offerings, VDE is a passively managed and advised by Vanguard Equity Investment Group. It has a lifetime average annual performance of 8.99%, which actually exceeds the return of the benchmark Spliced US IMI Energy 25/50 over the same time period (8.87%).
VDE has an expense ratio of 0.12%, which is very low for this or any category. The benchmark follows approximately 150 energy stocks based on market capitalization. As of mid-2015, the largest holdings were with Exxon Mobil (XOM), Chevron (CVX), Schlumberger Ltd. (SLB), ConocoPhillips (COP), Kinder Morgan (KMI) and Occidental Petroleum Corp (OXY).
Energy Select Sector SPDR ETF
State Street SPDR issues the largest energy sector ETF with the Energy Select Sector SPDR (XLE). This fund has nearly $13.5 billion under management and a trailing three-month volume average of more than 12 million trades per day. With expenses below 20 basis points, XLE is a popular and low-cost fund.
XLE is very similar to VDE; both are low-cost, focused on large-cap stocks and list Exxon and Chevron as their top two holdings. The main difference is that XLE is a little more weighted towards integrated oil and gas companies.
iShares U.S. Oil & Gas Exploration & Production ETF
BlackRock issues this ETF, which tracks the Dow Jones U.S. Select Oil Exploration & Production Index. It isn't nearly as large as the VDE or XLE, but it still has a steady volume (110,000+ trades per day).
The iShares US Oil & Gas Exploration & Production (IEO) isn't as cheap as its larger competitors – expenses run 0.46% – but it isn't as heavily weighted towards Exxon and Chevron. Instead, the larger holdings for IEO include ConocoPhillips and Anadarko Petroleum (APC). This should be considered a strong buy for investors who don't mind a little added risk.
iShares Global Clean Energy ETF
Another iShares series fund, the Global Clean Energy ETF (ICLN) is made for energy investors who want less exposure to oil and natural gas companies. Specifically, ICLN targets solar companies, wind companies and other producers of renewable forms of energy.
This fund manages more than $82 million in total assets in only 30 stocks, making it very concentrated. Despite a steep drop in 2011 and 2012, ICLN has been a top performer with a modest expense ratio (0.47%).
Market Vectors Oil Services ETF
The Market Vectors Oil Services ETF (OIH) is one of the most highly traded energy ETFs in the market, with a daily volume between 8.8 and 8.9 million. This is an energy equity ETF that targets the largest U.S. oil service companies.
Van Eck introduced this fund in 2011, and it has seen volatile movements since. This mirrors the performance of its underlying index, the Market Vectors U.S. Listed Oil Services 25 Index. Like many in the category, OIH is highly concentrated; 71% of its assets are covered in the top 10 holdings. The two largest holdings, Schulmberger and Halliburton (HAL), account for nearly one-third of the portfolio.
PowerShares DWA Energy Momentum Portfolio ETF
Most energy ETFs are very concentrated in the top 10 holdings, but the PowerShares DWA Energy Momentum Portfolio (PXI) is much more spread out. No single stock accounts for more than 6.5% of total assets, and only 39% goes to large-cap firms. This makes it attractive to those who want more eggs in the basket.