Are energy-related Exchange Traded Funds (ETFs) such as the U.S. Dow Jones Energy Index Fund (AMEX: IYE ) or the S&P Global Energy Sector Index Fund (AMEX: IXC ) suitable for investors who want to take advantage of rising energy prices?
Not everyone can drill for oil or get as lucky as Jed Clampett did. So why not use energy-related ETFs?
Roger Gibson's seminal work, Asset Allocation, points out that commodities have low correlations to stocks and bonds. Incorporating them with equities and bonds therefore lowers portfolio volatility.
However, using energy-related ETFs as a proxy for commodities presents a few problems. First, ETFs are baskets of stocks -- and they're going to behave like stocks, not raw commodity prices. So the benefits of diversification that Gibson noted are muted.
Second, energy prices are not tied solely to oil. Spot oil prices have declined around 8% from their highs, but spot natural gas prices are down almost 60%. Companies whose revenues are tied more to natural gas will be affected more severely than those with less exposure.
Finally, these two ETFs are heavily concentrated in a mere handful of stocks. More than 60% of each fund is invested in only ten stocks. If there is safety in numbers, you don't have it there.
Want more evidence? Just two companies, ExxonMobil (NYSE: XOM ) and British Petroleum (NYSE: BP ) , provide 26% of the S&P Global Energy Index. More dramatically, ExxonMobil and Chevron (NYSE: CVX ) provide more than 36% of the U.S. Dow Jones Energy Index.
These two ETFs are an extremely concentrated investment, and therefore risky. Basically, as long as ExxonMobil has record profits, both of these funds will perform well. But a better hedge against rising gas prices may well be a Prius.
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Fool contributor Buz Livingston likes kayaking in the Gulf of Mexico and believes most people can benefit from professional financial advice. He owns IYE, but not a Prius.