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By Daniela Pylypczak

Establishing exposure to the energy sector is by no means for the faint of heart. Positions in this corner of the commodity universe are ripe with risk and are often times associated with high volatility. But for those who can stomach the risk, allocations to energy can certainly pay off as demand continues to grow across developed and emerging markets alike. Investments in this sector can also be used as tactical tool to hedge against inflation, since increases in the price of commodities like oil and gas prices tend to ripple across the economy. For those who wish to establish a tactical tilt towards the energy sector, we outline an all ETF portfolio that is designed to give well rounded exposure to multiple segments of the energy market.

Portfolio Snapshot

First things first, here are the ETFs that we have chosen for this particular portfolio.

Ticker ETF Asset Type Allocation Expense Ratio
VT Total World Stock Index ETF International Equities 20.0% 0.25%
XLE Energy Select Sector SPDR ETF Domestic Equities 10.0% 0.20%
IEO Dow Jones U.S. Oil & Gas Exploration & Production Index Fund Domestic Equities 10.0% 0.48%
KOL Market Vectors Coal ETF International Equities 10.0% 0.62%
IPW SPDR S&P International Energy Sector ETF International Equities 5.0% 0.50%
OGEM Energy GEMS ETF International Equities 5.0% 0.85%
FCG ISE-Revere Natural Gas Index Fund International Equities 10.0% 0.60%
GSP S&P GSCI Total Return Index ETN Commodities 15.0% 0.75%
MLPI E-TRACS Alerian MLP Infrastructure Index Domestic Equities 15.0% 0.85%
Weighted Average Expense Ratio 0.55%

As can be seen above, there is really only one fund that is unrelated to the commodity industry. And although GSP is the only fund that invests directly in commodities, the other equity ETFs offer exposure to both domestic and international energy producers.

Holdings Overview

Below is a brief overview of each component of this portfolio.

  • VT: This ETF tracks the FTSE All-World Index, a benchmark comprised of approximately 2,900 stocks from 47 different countries, including both developed and emerging markets.
  • XLE: This fund is designed to invest in companies from the oil, gas & consumable fuels, and energy equipment & services industries.
  • IEO: This ETF tracks an index that seeks to capture the performance of the oil exploration and production sub-sector of the U.S. equity market.
  • KOL: This ETF tracks the Stowe Coal Index, offering investors exposure to publicly traded companies worldwide that derive greater than 50% of their revenues from the coal industry.
  • IPW: This ETF seeks to offer investors exposure to the non-U.S. energy sub-industry of developed countries included in the S&P Broad Market Index.
  • OGEM: This fund tracks the Dow Jones Emerging Markets Oil and Gas Titans Index, which is designed to track 30 of the largest emerging market companies in the Oil & Gas industry.
  • FCG: This ETF tracks an equal-weighted index that is comprised of exchange-listed companies, which derive a significant portion of their revenues from the exploration and production of natural gas.
  • GSP: This ETN is linked to a broad-based commodity index, which primarily invests in energy resources as well as precious metals and livestock.
  • MLPI:This ETN tracks a benchmark that is designed to offer investors exposure to the infrastructure component of the Master Limited Partnership asset class [see also Five Commodity MLPs With Sky High Yields].

Historical Return Analysis

Ticker 2008 2009 2010 2011
VT n/a 32.7% 13.1% -7.5%
XLE -38.8% 21.6% 21.8% 2.8%
IEO -41.8% 40.8% 18.7% -3.3%
KOL n/a 147.5% 31.3% -30.7%
IPW n/a 37.7% 4.7% -6.3%
OGEM n/a n/a 18.0% -20.6%
FCG -46.5% 50.1% 12.2% -7.2%
GSP -48.5% 15.3% 8.4% -1.4%
MLPI n/a n/a n/a 15.8%
Portfolio n/a n/a n/a -4.5%
Compare to SPY -36.7% 26.3% 15.0% 1.2%
Compare to AGG 7.6% 3.3% 6.4% 7.7%

The adjacent table provides historical results for each component of this portfolio, as well as backtested results (as available) for the entire portfolio during 2008, 2009, 2010, and 2011. The table also shows how this portfolio performed relative to a popular stock market benchmark (NYSEARCA:SPY) and bond benchmark (NYSEARCA:AGG).

It is important to note that many of the ETFs used in this portfolio have relatively short operating histories, limiting the extent of valuable historical return analysis.

Many equity and commodity ETFs in this portfolio suffered significant losses in 2008, as the global recession hammered equity and energy prices around the world. It is worth noting, however, the remarkable performance of KOL, which gained over 100% in 2009. As the energy industry continues to recover, many of these funds have been able to make up previous losses, while some have greatly outperformed the broad stock market, as represented by SPY.

Portfolio Expenses

This portfolio is designed for long-term use consistent with a “buy, hold, and rebalance” strategy. As such, minimization of expenses is necessary to avoid return erosion resulting from compounding costs. To this end, we constructed a portfolio with a weighted-average expense ratio of 55 basis points, which is significantly lower than fees charged by actively-managed mutual funds, which can exceed 1.0%. The impact of this reduced cost structure over a 30-year time horizon is significant [see also The Ten Commandments of Commodity Investing]:

Growth of $1 Million Over 30 Years @ Annual Return Of:

Portfolio Expense Ratio 5% 10% 15%
Energy Bull Portfolio 0.55% $3,694,581 $15,023,481 $57,379,730
Actively-Managed Mutual Fund Portfolio 1.00% $3,243,398 $13,267,678 $50,950,159

While this can certainly be used as an all encompassing group of holdings, those who wish to adopt an investment strategy that is tilted towards the energy sector can also use this model portfolio as a smaller part of their overall group of holdings.

Disclosure: Certain sections of this article were republished with permission from ETFdb.com. Click here to view the original portfolio. No positions at time of writing.

Disclaimer: Commodity HQ is not an investment advisor, and any content published by Commodity HQ does not constitute individual investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities or investment assets. Read the full disclaimer here.

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Source: Building An Energy Bull ETF Portfolio