Four Top Funds for the Energy Boom

06/17/2008 12:00 am EST

Focus: MARKETS

Timothy Middleton, contributor to MSN Money, finds two mutual funds and two ETFs he expects to capture any continuing rally in the energy sector.

In recent weeks, global stock markets have been in a wrestling match with the petroleum industry, with one side losing whenever the other blips ahead. Oil is winning overall.

But two related corners of the oil patch, drilling and oil-field services, have been doing even better than oil in general. [Both] Rydex Energy Services (RYVIX) and ProFunds Oil Equipment Services & Distribution Services (OEPIX) are ahead [around 17% this year].

Among exchange traded funds (ETFs), iShares Dow Jones US Oil Equipment and Services (NYSEArca: IEZ) and SPDR S&P Oil and Gas Equipment & Services (Amex: XES) are up around 20% this year.

Prudent investors saw the oil crunch coming years ago, and many of us have added natural-resources funds to our portfolios to gain additional exposure to this area. But now comes the second wave, investment in new production. The companies owned by these funds—drillers such as Noble and services firms like Halliburton and Schlumberger—will reap the profits that flow from this investment. These funds will be carried along in their train.

(Rydex Energy Services' minimum investment is $25,000. The ProFunds portfolio comes with a lower minimum but also with a higher expense ratio. You pay more for overhead.)

XES and IEZ have significant differences, including the way they trade. The iShares fund packs more assets into its biggest names, including a double-digit slug of Schlumberger, the granddaddy of the industry and noted for its high-tech innovations, including seismic work. But it has a higher expense ratio than the SPDR, [which also] trades more easily—a crucial difference.

Though the iShares fund is nearly twice as large, it trades in lower volume and with more strings. Shares can't be borrowed and sold short; the SPDR can. The SPDR is also marginable, meaning you don't have to pay for all the shares on the spot. You can also trade options on the SPDR, but not the iShares fund.

All things being equal, I would choose an ETF—in this case, the SPDR—over a mutual fund in this niche because its expenses and other friction costs, including taxable distributions as well as commissions, are the lowest. Though mutual funds have to pay annual capital gains distributions, ETFs do not.

But I would own this group—if not directly, at least in the form of an energy-sector fund. Every fund complex offers those, and if you still think single-sector funds are too risky, I would argue the greater risk is being left at the pump with nothing in your pocket but lint.

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