7 Ways to Win With Energy

In 2004, energy stocks began running laps around the broader market. So far, 2007 hasn't seen any change in that trend. Every energy-oriented fund listed below has more than doubled the market's return this year:

As often happens in investing, a rising tide lifts all boats. The buoyant price of oil is benefiting oil and gas producers, drillers, oil field service firms, solar companies, ethanol startups, and so on. Perhaps you've been on the sidelines, waiting for the cycle to turn down. That may be the most prudent approach, given energy's boom-bust historic cyclicality.

Then again, there's also a powerful case to be made for continued strength in crude oil prices. We've outlined plenty of reasons to anticipate such a scenario here at the Fool, ranging from the production declines of old and tired fields, to resource concentration in the hands of national oil companies, to a world demand outlook that keeps getting revised upward.

There's also a fairly large cushion today for the more conservative plays in the energy space. After all, the large integrated firms don't need $70 oil to turn a buck. The big boys of energy serve as the cornerstone of the majority of these funds, and for that reason, they're a great place to look if you're just dipping a toe into the oil patch for the first time.

Plain vanilla energy funds
The first three funds in the above table are nearly identical exchange-traded funds. They all track the U.S. energy sector. Thus, they all hold essentially the same basket of companies with slightly different weightings, according to the various indices used to construct the portfolio. ExxonMobil holds the top spot in each case, followed by Chevron.

The iShares U.S. offering gets a demerit for its unreasonably high expense ratio. It's also the most highly concentrated in its top 10 holdings, diminishing the benefit of its diversification. Between the SPDR and the Vanguard offering, we're splitting hairs a bit, but I think you're best served by the higher trading liquidity of the former.

Go abroad, get active
Next we have the iShares Global offering, which, like its American sibling, levies fees hardly justified by a mere index-tracking fund. This fund has less competition, though, so if you'd prefer to have some of the major international integrated firms in your energy basket, you'll have to pay up a little for the privilege.

For those seeking a more active management approach, I offer up one closed-end fund, Petroleum & Resources Corporation. This fund outdates the Great Depression, so there's a lot of institutional memory here. Its long history informs a conservative investment approach that emphasizes preservation of capital above all else. The fund caught my eye because it trades at roughly a 10% discount to its net asset value, a phenomenon I recently explored, letting investors here pick up their energy basket from the sale rack. True to its conservative stance, the fund has lagged indexes amid the energy market's recent years of ebullience. But it had smaller losses than the Energy SPDR in 2001 and 2002, when energy stocks last hit a rough patch. This tendency may appeal to those who don't want to worry about timing the energy cycle.

For the enterprising only
At the opposite end of the risk spectrum lie an oil services-only fund and a clean energy fund. Oil service firms are the most volatile part of the oil and gas industry. They tend to lead the way up when crude is rising, but they fall much harder than the large, integrated firms when the cycle turns down. Couple this downside exposure with the highly concentrated nature of this particular basket -- only 18 stocks in all -- and you've got a real hot potato. Handle this one with care.

Speaking of potatoes, somewhere in the WilderHill fund's portfolio, there's undoubtedly a small-cap company with a plan to make renewable energy from potatoes. There are a lot of speculative endeavors represented here, and this clean energy group is sure to be the most volatile of all. I don't like how heavily solar companies are weighted in this fund -- six of the top 10 holdings are solar firms. But if you think that solar is the best thing since sliced Sunbeam bread, this might be the play for you.

Related Foolishness:

• Take THAT, Big Oil!
• Who's Making Windfall Profits?
• A Different Kind of Alternative-Energy Portfolio

The PowerShares WilderHill Clean Energy ETF is a Motley Fool Rule Breakers selection. Discover David Gardner's entire lineup of cutting-edge growth stocks with a free 30-day trial.

Fool contributor Toby Shute owned a potato-powered clock in his youth. The technology never really seemed to catch on, but it was pretty cool. He doesn't own shares in any company or fund mentioned. The Motley Fool has an energetic disclosure policy.