Investing In Oil & Gas A Bit More Prudently

Summary

• To play the (still forthcoming) rebound in the oil & gas space, I prefer to use diversified sector funds.
• The Vanguard Energy ETF looks like a reasonable investment tool due to its diversified nature and low management fees.
• But don't forget, putting money in oil & gas is not without significant risks.

It has been, perhaps not unexpectedly, a roller-coaster ride.

After WTI crude prices shot from 52-week lows of $47/barrel in June 2017 to about $65/barrel early this year (see graph below), concerns over rising inventories seem to have capped the recovery at the low $60s level. In February, equities in the energy space experienced the worst month of returns in the past two years, driven in large part by the lack of additional good news on the commodities front to support the late 2017 rally.

(Credit: Macrotrends)

But I am not ready to throw in the towel on the oil & gas industry just yet. As I mentioned not long ago, the narrative coming from a few key players in the space seems to be largely bullish on the macro trends. What I am not willing to do, however, is make isolated bets that could overlay volatility and uncertainty driven by company-specific risk on top of an already volatile and uncertain sector.

To play the potential rebound in the oil & gas space more prudently, and I have been doing so using only a small chunk of my portfolio, I prefer to turn to diversified sector funds. And my index fund of choice for the past couple of years has been the Vanguard Energy ETF (NYSEARCA:VDE).

What I like about the fund

Being a cheapskate at heart, one of the key factors weighing on my decision to pick an ETF over its competitor is management fee. And when it comes to costs, it is hard to beat Vanguard's product portfolio. See the chart below ranking the top 8 energy ETFs by admin expenses.

(Source: ETFdb.com)

Notice that VDE is not the number one pick on the list above, trailing Fidelity's product, the Fidelity MSCI Energy Index ETF (FENY). But compared to its peer, VDE is a better-established (inception year 2004 versus 2013), larger (AUM of $3.9 billion versus $477 million) and more liquid alternative. And although small differences in cost can add up when compounded over very long periods of time, it is hard to think of a 0.1% annual management fee as anything but enticing.

When it comes to portfolio holdings, VDE is invested in 142 names and concentrates only 64.9% of its assets in the top 10 names. For comparison, perhaps the largest and most well-known peer, the Energy Select Sector SPDR ETF (XLE), holds only 33 stocks and concentrates nearly 72% of its AUM in the top 10 players. Following the rationale that diversification is better in an otherwise volatile sector, VDE seems to be a better alternative versus some of its larger competitors out there.

Below is a snapshot of what VDE is currently invested in. It very closely mirrors the benchmark that it tracks, the MSCI US IMI Energy 25/50 Index, other than a slight bias towards medium-cap in lieu of small-cap stocks compared to the benchmark. I find the ETF conservative enough within the context of a volatile sector, as over 70% of its assets are invested in mega- and large-cap names, with nearly 40% parked in giant integrated O&G companies. It also pleases me to see that none of the speculative offshore drillers make the top 40 holdings list, with Transocean (RIG) being the largest OSD piece at only 0.3% allocation.

(Source: D.M. Martins Research)

Last few words

Putting money in oil & gas is not without significant risks. If I were to give the reader one piece of advice, it would be to only approach the energy sector (amid a still-tough landscape) in the context of a risk-balanced portfolio. And secondarily, going broad and diversified instead of deep and concentrated is probably a better option for most retail investors.

Once a decision to invest in O&G is made, looking at VDE might be a logical next step, in my view.

Analyst’s Disclosure: I am/we are long VDE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[Cchglies]

I'm definitely committed to VDE long term......because I bought in high the beginning of last year....ouch!

[DM Martins Research]

I bought my first batch of VDE in 2015 at $104 -- not cool. But dollar-cost averaged all the way down to the $80s and sold quite a bit at around $100 recently. Buying when the price drops might be a good idea, provided the investor is not overexposed.

Good luck!

[jse111]

Spot-on article and well done. Before we worry too much about low future oil prices, I simply state that Ghawar and its 174 mile diameter discovered in 1947 (not a typo) is far closer to "all done" than full capacity.