Diversifying with Energy ETFs
Why would you invest in energy?
Well, historically, most energy commodities have maintained their value against rising inflation. Additionally, energy prices are inversely correlated to the U.S. dollar, which makes energy ETFs a good hedge against a depreciating dollar.
The demand is not only there, but it’s increasing, too. As emerging markets continue to industrialize, demand for energy commodities is expected to continue to grow. It is unlikely that oil reserves will continue to satiate our appetites indefinitely, so we may be faced with a future of rising demand with slowly decreasing supplies.
But that, of course, will only present further opportunities for investing in other types of energy: solar, wind, natural gas, nuclear power and so on.
Modern portfolio theory suggests that investors may increase portfolio risk-adjusted returns by using low-correlating assets. Oil is one such investment that produces a low, or even negative, correlation with U.S. stocks. But always be sure that you’re ready to keep an eye on these investments and have an exit plan in place.
There are two primary ways to get exposure to energy via ETFs:
- Equities. This includes such funds as PowerShares Dynamic Oil & Gas Services (NYSEArca: PXJ), iShares Dow Jones U.S. Oil & Gas Exploration (NYSEArca: IEO) and Guggenheim Solar (NYSEArca: TAN). These and other similar ETFs simply track an index of companies involved in the manufacturing and production of energy.
- Futures. The other type of energy commodity ETF tracks a basket of futures contracts. This is a relatively new area for many investors, who would have found it cost-prohibitive and time-consuming to invest in futures. This type of ETF includes funds like United States Natural Gas (NYSEArca: UNG) and PowerShares DB Oil (NYSEArca: DBO). When investing in these funds, be sure that you understand the impact that contango might have.
To get started on investing in energy ETFs for your clients, there are a few ways to get started:
- You can check out one of our many model portfolios; several of them include energy exposure.
- You can find commodity ETFs in the ETF Analyzer, and then add them to your Watchlist on the ETF Dashboard.
- Once you have some energy-related ETFs in possession, set up alerts to be notified of a trading opportunity.