December 31, 2010

Energy ETFs Getting Lift From Rising Oil Prices

Rising oil prices have helped energy stocks outperform the broader market in recent months

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It may be hard to believe, but while everyone was out enjoying their holiday office parties, buying gifts and eating too much, the U.S. economy appears to have shifted into growth mode.

More than a few recent economic indicators point to a strengthening U.S. economy.

The Conference Board’s Leading Economic Index rose in November for a fifth consecutive month helping to “confirm the strength of the recovery, and suggest that the economy is reaccelerating after its late summer doldrums,” according to Standard & Poor’s chief economist David Wyss.

Consumer sentiment is at a six-month high, durable goods orders are running 14% ahead of last year’s pace despite a hiccup in airplane orders, and new home sales are finally starting to increase as well. Plus, the S&P 500 has ended the year having recouped substantially all of the losses it suffered since Lehman Brothers declared bankruptcy in September 2008.

Another indicator of accelerating economic growth is the rising price of oil. In December, benchmark U.S. crude oil prices climbed past the $90 a barrel mark for the first time since early 2008, amid slumping domestic crude oil inventories and optimism that demand will rise as economic activity picks up.

Rising oil prices have helped energy stocks outperform the broader market in recent months.

Energy Switch

If favorable economic conditions persist into the New Year, investors may benefit from initiating or adding to their exposure to energy equities. Overall, S&P recommends a marketweight position for energy stocks.

Of the seven sub-industries, S&P analysts have a positive outlook for the Integrated Oil & Gas group, which dominates the sector’s market cap, and are largely neutral on the others.

ETF investors have a wide variety of choices when it comes to the energy sector. There are two dozen energy ETFs offering access to strategies that target both domestic and international equities. Most of these funds focus on large oil and gas companies, though some own small cap companies, natural gas or coal companies.

Four of these funds -- State Street’s SPDR Energy Select Sector Fund, the iShares S&P Global Energy Sector Index Fund, the iShares Dow Jones US Energy Sector Index Fund and the Vanguard Energy Index Fund -- have an “Overweight” recommendation from Standard & Poor’s, which assess funds using 10 different metrics measuring performance, risk and cost.

While these funds are all attractive in their own right, their holdings are nearly identical to each other. Each fund hast ExxonMobil as its top holding, with weightings varying from 24% (iShares Dow Jones US) to 14% (iShares S&P Global), followed by Chevron as the second largest.

The State Street, iShares Dow Jones US and the Vanguard funds have exactly the same top six holdings. The iShares S&P Global fund also owns almost all of the same stocks in its top 10 holdings as well. Furthermore, most investors already own these stocks in large cap or broad market index funds.

ETF Options

Of these funds, the State Street fund is the largest and least expensive to own, followed by Vanguard, while the iShares S&P Global ETF has the largest dividend yield.

Performance among the group has been highly similar as well, though the iShares S&P Global fund has underperformed the others over the past year.

Among other energy ETFs, the PowerShares Dynamic Energy Sector Portfolio merits some attention. Launched in October, 2006, it owns the best one-year and three-year performance records of the group and is one of only two funds with a positive return over the past three years, though its annual expenses are somewhat higher than the others.

The fund uses PowerShares “Dynamic” allocation model, in which 30 stocks are selected based on a proprietary ranking system. As of September 30, the fund’s top three holdings were Houston-based Newfield Exploration Co., an oil and gas exploration and production company with domestic and international properties; drilling equipment vendor National Oilwell Varco, and coal producer Peabody Energy.

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