Energy Mutual Funds

Energy mutual funds are the best way for individual investors to make a diversified invest in the Energy sector. The Energy sector becomes ever more important as the world's population continues to grow, becomes more prosperous and demands more energy per capita. Satisfying the world demand for energy, in one form or another, presents some very serious economic and geopolitical issues that need to be addressed and, as such, offers a wide variety of investing opportunities. As you can imagine, the Energy sector is currently (Nov. 2007) red hot.

The Energy sector is broad and diverse and can be subdivided into many segments. There are some very diverse Energy mutual funds that invest in just about anything that is remotely related to energy and there are some very specialized funds that invest in businesses such as oil field services or gas transmission pipelines.

Crude oil, natural gas and sometimes coal are covered in the commodities segment of your portfolio, which is covered in a subsection dedicated to commodities. It would be nice to segregate them from the other commodities, but I don't know of any commodity mutual funds that don't have an energy component, and that energy component is always composed of some combination of oil, gas and coal. If you add a Natural Resources fund to your portfolio it, too, will most likely have a significant investment in oil, gas and coal.

Energy is a sector that is hard not to duplicate, as it's included in so many other types of funds. Energy is so important to our economy that the various types of energy companies are well-represented in all four market capitalization brackets and therefore in most broadly diversified mutual funds. So the question you must answer is "How much of your portfolio do you want to be devoted to Energy?"

When you start looking for energy-related companies in your various mutual funds, you will probably find a lot more than you expected and you'll probably find some in funds that you wouldn't have thought would have an energy component. This overrepresentation is partly due to the high returns the Energy sector has been delivering. Adding a few energy companies to a mutual fund is an easy way for a fund manager to juice a fund's performance.

Natural Resources mutual funds are a good place to find energy stocks. Most of them have always had an energy component but many of them are getting overloaded with energy stocks because of the high returns and because they're competing with each other, so if one does it they all do it. You'll also find energy stocks in the portfolios of Utility funds, Transportation funds (they sometimes invest in pipelines), and Socially Responsible and Green funds to the extent that they invest in Alternative Energy. If you're not paying attention, you could end up owning a lot more energy-related stock than you had intended, and Energy is a very volatile sector. Indeed, you may not need a pure energy play to satisfy your needs in this sector.

As our society currently exists, energy prices have a strong link to inflation. Rising energy prices won't always lead to inflation but they definitely have the potential to light that fire. So the energy component of your portfolio can be considered, to some degree, as a hedge against inflation. It's a bit like buying oil futures. If the price of oil rises significantly faster than the price of everything else, you'll be paying more for gas, heating oil, electricity and anything made with petroleum products or transported by any means that involves burning petroleum products. However, your additional costs will be offset by the excess gains of the energy component of your portfolio.

The Energy sector is only moderately correlated with the general market, thus it provides some diversification potential. But buying Energy mutual funds should be one of the last considerations in building your portfolio. You need to determine how much Energy is embedded in the rest of your portfolio before you add any Energy mutual funds. We'll talk about this more in the discussion of the Natural Resources sector and in the Commodities subsection.

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Move on to the next subsection, Financial Services Mutual Funds.