What are Energy ETFs
An energy exchange-traded fund (ETF) is a hybrid equity instrument focused on companies dealing in oil, natural gas and alternative energy products. The components of an energy ETF can include an entire sector index, domestic or international energy producers, energy equipment manufacturers or certain sub-sectors like coal, alternative energy or oil. For investors, the sector's diversity can offer exposure to various points along the value chain.
BREAKING DOWN Energy ETFs
Energy ETFs cover a variety of business types, regions and risk profiles. As a result, energy ETFs are popular among both conservative and aggressive investors. Since the energy sector represents a significant part of the global economy, nearly all investors with balanced portfolios has some exposure to energy companies. Energy's high percentage allocation within broad market averages like the S&P 500 is evidence.
The energy sector is large, all-encompassing and important thread throughout the global economy. It is a highly complex and sophisticated network of companies involved in the production and distribution of energy needed to power everyday life. As a result, supply and demand for global energy is an outsized factor in sector performance. Oil and gas producers typically outperform when oil and gas prices are high, and often earn less when the value of the commodity declines. On the other hand, when crude prices drop, oil refiners can benefit from the falling cost of feedstock to produce petroleum products like gasoline. Furthermore, this sector can be sensitive to politics, which often drives changes in oil prices.
Prominent Energy ETFs
A number of energy related exchange-traded funds provide retail investors exposure to different areas of the sector. For example, the SPDR S&P Oil & Gas Exploration & Production ETF (XOP) opens the door for investors to invest in upstream oil and gas exploration companies. The VanEck Vectors Coal ETF (KOL) gives investors entry to the coal industry. Investors wanting access to the growing alternative energy market can invest in the Guggenheim Solar ETF (TAN) as well.
It's worth noting that intraday pricing and trading is an advantage for Energy ETFs, as they can make this ETF segment more attractive than similarly invested mutual funds. Reviewing the fact sheets and prospectuses may be a prudent move for investors interested in an investment in ETFs, especially when looking to invest in commodities, which can be volatile. ETFs provide diversification, but like any asset there are risks to consider. For example, a sector-based ETF like one that tracks stocks associated with natural resources could add measures of volatility to a portfolio.