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Six ways investors can play a recovering energy sector

These ETFs should serve investors who have been watching oil prices rise and economic growth accelerate around the globe

By: SHIRLEY WON

Date: November 02, 2017

Amid a rally in crude oil prices and signs of global economic growth, investors might be tempted to bet on a recovering energy sector.

Because the price of crude has been volatile in its climb to around $54 (U.S.) a barrel recently in New York from less than $30 early last year, it may be easier and more prudent to invest in exchange-traded funds (ETFs) rather than individual stocks.

Given uncertainty about OPEC production cuts and continuing debate about the rally's sustainability, investors might also consider a tactical approach aimed at shorter-term potential profits. However, investors who have a big weighting in Canadian equity funds may already have sufficient energy exposure.

We asked three ETF experts for their top picks to play an energy recovery.

Daniel Straus, ETF analyst at National Bank Financial Inc., Toronto

• The pick: VanEck Vectors Oil Refiners ETF

• Management expense ratio: 0.59 per cent

This global oil-refiner ETF has diversification potential because it can do well when energy prices rise, or when they fall, says Mr. Straus. Refineries transform crude oil into gasoline, jet fuel and other products. The "crack spread," which is the price difference between crude and petroleum products, has been rising this year, he said. "Our energy analysts [at National Bank] believe the refineries are still in a recovery mode." Refiners, however, can also benefit when the price of crude falls, since it is their key raw material, he said. The dynamics of the energy market have worked in this ETF's favour as it gained 40 per cent for the year ended Sept. 30, he said. This fund is suited to aggressive or tactical investors because buyers face a risk that oil prices could rise faster than the price of petroleum products, he added.

• The pick: BMO Junior Oil ETF

• MER: 0.59 per cent

This junior oil-and-gas ETF has more upside potential than its larger-cap peers when commodity prices rise, but also more downside when they fall, says Mr. Straus. The ETF, which traded at around $30 a unit in 2014, is now hovering around $12. It is suited to investors who are "confident in their bullish attitude towards the price of oil," he said. This fund invests in oil and gas explorers and producers, as well as equipment, service and drilling firms. Its 50 holdings include Crescent Point Energy Corp. and Whitecap Resources Inc. Large-cap companies may be a safer way to play the oil market, but they tend to have many business lines and commodity hedges into the future, he said. "That complicates their relationship to the price of crude."

Denise Davids, ETF and mutual fund analyst, Industrial Alliance Securities Inc., Toronto

• The pick: Energy Select Sector SPDR ETF

• MER: 0.14 per cent

This ETF, which tracks energy stocks in the S&P 500 index, is a low-cost way for investors to tap into the space, says Ms. Davids. "The United States is one of the leading oil-producing countries in the world, and this ETF provides a good way to gain access to its energy sector." It holds 32 securities. Because this fund tracks a market-cap-weighted index, the percentage weighting of the firms in the ETF depends on their market value. The portfolio is top heavy in Exxon Mobil Corp. and Chevron Corp., which make up 40 per cent of the ETF. Negative news affecting these two industry giants, such as serious disruptions at major refineries or a lack of production growth, could hurt this fund, she noted. This easily tradeable ETF is suited to investors who can tolerate moderate risk, she said.

• The pick: iShares S&P/TSX Capped Energy Index ETF

• MER: 0.62 per cent

Investors will get diversified exposure to the Canadian energy sector in this fund, but its fee is "pretty high" compared with that of its U.S. ETF peer, says Ms. Davids. This fund tracks 39 names that make up about 20 per cent of the S&P/TSX composite index, and it's the only broad Canadian energy ETF available, she noted. The fund holds oil and gas explorers, producers, integrated companies and drillers as well as oil-service firms. The portfolio is top heavy, with names such as Suncor Energy Inc. and Canadian Natural Resources Ltd. making up about 45 per cent of the ETF. About 13 per cent is invested in small-cap stocks, which tend to be more sensitive to commodity-price movements and can "exhibit higher bouts of volatility." This fund is suited to higher-risk investors, she said.

David Kletz, ETF analyst and portfolio manager, Forstrong Global Asset Management Inc., Toronto

• The pick: Global X MSCI Norway ETF

• MER: 0.50 per cent

This Norwegian equity ETF, which has 26 per cent in energy companies, offers a diversified and less volatile way to play a recovery in the industry, says Mr. Kletz. Among oil-dependent nations, Norway is a standout, he said. "With geopolitical tensions flaring up worldwide, Norway's high degree of political stability is important." But other areas of the Norwegian economy, which are represented in the fund, "have a high degree of sensitivity to the energy sector as well," he noted. Norwegian financials, which make up 24 per cent of the ETF, carry a large loan-book exposure to energy firms. The fund's largest names are Statoil ASA, DNB ASA and Telenor ASA. The risk comes from the fact that the top 10 holdings represent more than two-thirds of this unhedged ETF, he said.

• The pick: SPDR S&P Oil & Gas Exploration & Production ETF

• MER: 0.35 per cent

This ETF, which tracks U.S. oil-and-gas explorers and producers, should outperform more broad-based energy-sector ETFs when commodity prices rise, says Mr. Kletz. This group has more upside potential than its peers involved in the transportation, storage and refining of crude. This ETF is suited to aggressive investors with a high-risk tolerance and long-term horizon because 35 per cent of the holdings are in the more volatile, smaller-cap companies, he noted. The ETF's 64 equal-weighted names include Carrizo Oil & Gas Inc., Whiting Petroleum Corp. and Marathon Oil Corp. "While oil prices have been relatively stable since mid-2016, it is not uncommon during a bear market for prices to appreciate and depreciate rapidly," he cautioned. Forstrong, he said, is not expecting a renewed bull market soon.

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