5 Questions to Ask When Buying an Energy ETF

by on March 12, 2014 | ETFs Mentioned:

The energy sector is among the fastest-moving market segments in the world, as its make-up changes significantly as the years go on. The rapid development of technology and new sources of energy has helped this segment remain one of the hottest investing spaces for decades. Energy ETFs have especially taken off in recent years, as they have allowed investors to invest in all of their favorite energy firms and strategies under one ticker [for more ETF news and analysis subscribe to our free newsletter]

When it comes time to make an energy allocation, there are several important factors investors should keep mind. Below, we outline five important questions every investor should ask before choosing the energy ETF that is right for their objectives.

1.What kind of energy investment are you making?

Within the energy sector there are dozens of sub-sectors, each with very different risk/return profiles. While it may seem basic, the first thing you will want to decide is what kind of energy investment you want to make. Here are a few popular ETFs for some of the most sought-after energy sectors:

Discipline ETF
Big Oil Energy Select Sector SPDR Fund (XLE, A)
Oil Services Market Vectors Oil Services ETF (OIH, B+)
Exploration SPDR S&P Oil & Gas Exploration & Production ETF (XOP, B+)
MLPs Alerian MLP ETF (AMLP, A-)
Natural Gas First Trust ISE Revere Natural Gas Index Fund (FCG, C+)
Equipment & Services SPDR S&P Oil & Gas Equipment & Services ETF (XES, A-)
Fracking Market Vectors Unconventional Oil & Gas ETF (FRAK, B-)
Oil Sands Sustainable North American Oil Sands ETF (SNDS, B+)
International SPDR S&P International Energy Sector ETF (IPW, A-)

2. Are you over-exposed?

The oil industry is not without its options, but it is safe to say that from a market cap standpoint, it is dominated by a select few companies. Exxon Mobil (XOM) and Chevron (CVX) are two of the largest companies in the world, and as such, they are very well represented in the ETF world. Investors will want to be careful that their fund is not over-exposed to a select few companies; if you have a strong conviction for one or two oil producers, you are better off owning their stock instead. The following chart shows XOM and CVX’s combined weight in the three largest energy ETFs in the world: XLE, VDE, and IYE.

Digging deeper into our Energy Equities category can help you find a fund that may rely less on these two giants. You may also want to consider the S&P Equal Weight Energy ETF (RYE, A-), which grants an equal weight to all of its energy holdings.

3. What does the future hold?

Oil Drilling Rig in ArgentinaAs we begin to explore opportunities beyond crude oil and work to ween ourselves off of the source that has supported us for years, future prospects in your investment are vital. Some oil firms are currently focused on maintaining their position and ensuring their dividends are stable for investors. Others are spending on R&D and moving into younger sub-sectors like fracking, oil sands, natural gas, and others. Take a look under the hood of your prospective investment and make sure that the companies’ future aspirations line up with your objectives.

4. What kind of strategy do you want?

The energy industry is home to some of the most stable blue chips in the world, while at the same time, it’s a breeding ground for young firms looking for growth potential in an ever-shifting energy space. It is important that you decide what kind of return and fund you are looking for.

If it’s value and solid income you are after, the big oil names will probably serve you best as their dividend policies are taken very seriously. When it comes to growth, you may want to look into fracking and oil sands among other young strategies that have big-time potential. Also note that there are energy ETFs that focus solely on small caps, quantitative methods, and others that investors may find appealing.

5. How much do you want to pay?

As is a common theme in the ETF world, expenses will come into play when making your choice for an allocation. The blue-chip strategies will typically fall under the low end of the spectrum, but as the fund’s investment objectives get more obscure, the expenses increase. Below, we display the 10 cheapest energy equity ETFs currently on the market:

ETF Expense Ratio
MSCI Energy Index ETF (FENY) 0.12%
Energy ETF (VDE) 0.14%
Energy Select Sector SPDR (XLE) 0.18%
S&P SmallCap Energy Portfolio (PSCE) 0.29%
SPDR S&P Oil & Gas Explor & Product (XOP) 0.35%
SPDR S&P Oil & Gas Equip & Service (XES) 0.35%
Market Vectors Oil Services ETF (OIH) 0.35%
iShares MSCI Global Energy Producers ETF (FILL) 0.39%
iShares Global Energy ETF (IXC) 0.48%
iShares U.S. Energy ETF (IYE) 0.48%

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Disclosure: Long XOM.