Best And Worst Funds: Energy Sector

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Includes: BHI, ERX, XOM
by: David Trainer

The Energy sec­tor ranks sev­enth out of the ten major sec­tors as detailed in our sec­tor roadmap. It gets my Dan­ger­ous rat­ing, which, like my fund rat­ings, is based pri­mar­ily on aggre­ga­tion of stock rat­ings for each of the 191 com­pa­nies in the sec­tor. The Energy sec­tor is near the bot­tom of the sec­tor bar­rel.

Per Fig­ure 1, Energy sec­tor stocks do not look that bad. Over 40% of the mar­ket cap of the sec­tor gets my Attrac­tive rat­ing. The prob­lem is that fund man­agers in the sec­tor are not allo­cat­ing enough of their port­fo­lios to the Attrac­tive stocks. Nearly 99% of Energy fund assets get my Dangerous-or-worse rating.

Investors should sell funds in this sec­tor because the cost of port­fo­lio man­age­ment (active or pas­sive) is not jus­ti­fied. Investors can out­per­form by pick­ing bet­ter stocks on their own while also avoid­ing the costs of putting money into a fund.

Fig­ure 1: Energy Sec­tor Land­scape For Funds & Stocks


Sources: New Con­structs, LLC and com­pany filings

If you are forced to choose a fund in the Energy sec­tor, know that all 97 funds are very dif­fer­ent. Per Fig­ure 2, the num­ber of hold­ing varies widely (from 23 to 167), which cre­ates dras­ti­cally dif­fer­ent invest­ment impli­ca­tions and rat­ings. Here is the full list of 97 funds.

How do investors pick the right fund out of the sea of choices that will deliver the best returns?

Fig­ure 2: Funds with Most & Least Hold­ings - Top 5


Sources: New Con­structs, LLC and com­pany filings

To iden­tify the best funds within a given cat­e­gory, investors need a pre­dic­tive rat­ing based on analy­sis of the under­ly­ing qual­ity of stocks in each fund. See Figure 3.

Our pre­dic­tive fund rat­ings are based on aggre­gat­ing our stock rat­ings on each of the fund's hold­ings and all of the fund's expenses. Investors deserve forward-looking fund research that is com­pa­ra­ble in qual­ity to stock research.

Investors should not rely on backward-looking research of past per­for­mance for invest­ment decisions.

Fig­ure 3 shows the five best and worst-rated funds for the sec­tor. No funds allo­cate enough value to Attractive-rated stocks to earn an Attractive-or-better rat­ing. Direx­ion Daily Energy Bull 3X Shares (NYSEARCA:ERX) does allo­cate 42% of its value to Attractive-rated stocks but earns my Neu­tral rat­ing because of its high allo­ca­tion to Dangerous-or-worse rated stocks. In addi­tion to stock selec­tion, my rat­ings account for the total annual cost of invest­ing in a fund or

One of my favorite stocks in the Energy sec­tor is Exxon Mobile (NYSE:XOM), which gets my Attrac­tive rat­ing. The fund that allo­cates the most (at 27%) to XOM is (ERX) though it gets a Neu­tral rat­ing. Per­for­mance of XOM has been up and down over the past few years - kind of like our econ­omy. When it gets cheap, it is hard to pass up given its lead­er­ship in the Energy sec­tor. Most will agree that demand for energy is on the rise for the fore­see­able future. Yet XOM's cur­rent val­u­a­tion (~$83.74/share) implies the com­pany will not grow its prof­its more than 10% over the remain­der of its cor­po­rate life. That seems a bit pes­simistic for the world's largest publicly-traded inter­na­tional oil and gas com­pany. It is also one of the most prof­itable com­pa­nies in the world.

One of my least favorite Energy stocks is Baker Hughes (NYSE:BHI), which gets my Very Dan­ger­ous rat­ing. I also rec­om­mend investors sell Fidelity Select Port­fo­lios: Energy Ser­vice Port­fo­lio (MUTF:FSESX), the fund that allo­cates the most (about 8%) to BHI. Investors should sell BHI because of its over­stated earn­ings and expen­sive val­u­a­tion. BHI's account­ing earn­ings have ben­e­fited sig­nif­i­cantly from the BJ Ser­vices acqui­si­tion that closed in late April 2010. How­ever, the eco­nom­ics, i.e. the result­ing cash flows, of the deal are not pos­i­tive. One of the biggest mis­con­cep­tions in the invest­ing world is that the merit of an acqui­si­tion should be judged by whether or not it is "earn­ings accre­tive". As I detailed in this report, the impact of an acqui­si­tion on account­ing earn­ings is not indica­tive of its eco­nomic value to share­hold­ers. Though the stock has fallen from ~$58 to ~$49 since I wrote the aforementioned report, it is still on my Most Dan­ger­ous Stocks list, The cur­rent val­u­a­tion implies the com­pany will grow, organ­i­cally, its after-tax cash flow [NOPAT] by over 20% com­pounded annu­ally for 10 years. That seems a bit of a stretch.

Fig­ure 3: Funds with the Best & Worst Rat­ings - Top 5


* MF des­ig­nates Mutual Funds and ETF des­ig­nates Exchange-Traded Funds

Sources: New Con­structs, LLC and com­pany filings

Investors should avoid all Energy funds. 95 of the 97 funds allo­cate enough value to Dangerous-or-worse-rated stocks to earn a Dangerous-or-worse rat­ing. Fig­ure 4 shows the rat­ing land­scape of all ETFs and mutual funds in the Energy sector.

Our Sec­tor Roadmap report ranks all sec­tors and high­lights those that offer the best investments.

Fig­ure 4: Sep­a­rat­ing the Best Funds From the Worst


(Click to enlarge)

Sources: New Con­structs, LLC and com­pany filings

Fig­ure 5 lists our Pre­dic­tive Fund Rat­ing for the 5 largest and most pop­u­lar Energy funds.

Fig­ure 5: Five Largest Energy Funds


* MF des­ig­nates Mutual Funds and ETF des­ig­nates Exchange-Traded Funds

* Analy­sis uses the top-ranked class for each fund

Sources: New Con­structs, LLC and com­pany filings

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: I am not removing the duplicate language as requested because these reports are not to be read by the same person every time. Each report should stand on its own.Where is the ticker box for adding tickers? I do not see that in your new system.The images may be small, but they are legible. Several other articles with the same size images have been published by you. In fact, my articles on Best & Worst Funds for the technology, Consumer Disc, Consumer Staples and Industrials have all been published already without any changes by me.