Investing in Energy Mutual Funds

Investment management companies want to make money, and so do you. To achieve this goal, they create mutual funds with certain objectives. Like-minded energy investors who have the same goal as the fund pool their money together, giving control to a fund manager who's responsible for building a collective portfolio filled with investments that fall within the specific criteria, and voilà.

Three basic types of mutual funds are available to investors, and each comes with its own strategy to suit your needs:

  • Fixed-income funds (bonds)

  • Money market funds

  • Equity funds (stocks)

For the purpose of focusing your investments within the oil and natural gas industries, you can narrow down the playing field to stock funds, often referred to as equity funds.

Stock funds can be broken down into several categories:

  • Growth funds focus on returning large capital gains for investors rather than steady dividends.

  • Income funds are exactly what they sound like. These funds concentrate on stocks that offer regular dividends.

  • Index funds try to mirror the return of a specific market index by investing in stocks found within that index. For example, a fund attempting to replicate the performance of the Dow Jones Industrial Average builds a portfolio consisting of either all or at least a sample of stocks on the Dow.

  • Sector funds target a particular industry or sector of stocks.

Energy funds broaden their investments beyond simple exploration and production stocks. They also include service stocks or those that offer transportation and equipment.

Today, energy mutual funds represent a huge amount of investment capital. This table shows you five of the top-ranked energy mutual funds available for long-term investors according to combined ratings from Morningstar, Lipper, Zacks, TheStreet.com, and Standard & Poor's.

Top-Ranked Energy Mutual Funds
Name Ticker Symbol Net Assets Top Five Holdings
Icon Energy Fund ICENX $622 million ExxonMobil Corporation, Chevron, Valero Energy Corp., Schlumberger, Tesoro Corporation
Integrity Williston Basin/Mid–North America Stock Fund ICPAX $548 million National Oilwell Varco, Kodiak Oil & Gas Corp., Halliburton, Oasis Petroleum, Whiting Petroleum
Fidelity Select Energy Portfolio FSENX $2.1 billion ExxonMobil Corporation, Chevron, Occidental Petroleum, National Oilwell Varco, Hess Corp.
Fidelity Select Natural Resources Portfolio FNARX $1.1 billion Occidental Petroleum, Hess Corp., Halliburton, Suncor Energy, National Oilwell Varco
Vanguard Energy Fund VGENX $11.8 billion ExxonMobil Corporation, Chevron, Royal Dutch Shell, BP PLC, Occidental Petroleum

Because funds come in all different shapes and sizes, each with its own specific investment goals and objectives, you must consider several factors when choosing an energy mutual fund. Identifying the right fund for you can be just as difficult as evaluating individual oil and gas stocks. So what do you look for, and more important, how do you find your answers?

  • Performance: Contrary to popular belief, a mutual fund's performance in the past isn't as critical as you may think. Smaller funds new to the market may appear extremely attractive because they've invested in just a few stocks. As funds increase in size, their portfolio size also grows, making it less likely that the fund will repeat its short-term success.

    A mutual fund's performance, however, gives you some insight into its volatility during a specific time frame — more volatility leads to higher risk.

  • Risk: Every investment you ever make in the market comes with a certain degree of risk. If that weren't the case, everybody would invest, and everybody would cash in on the market. Unfortunately, that simply isn't the case. To mitigate risk, read a fund's prospectus from top to bottom to learn its investment strategy, and determine whether it's best suited to meet your level of risk.

  • Fees: Along with risk, always factor cost into your decision to buy a fund. You can expect to see typical things like shareholder transaction fees charged to you every time you buy and sell a fund's shares. Among these fees are sales charges on purchases, purchase fees, deferred sales charges, redemption fees, exchange fees, and account fees.

  • Expenses: Another important piece of due diligence is determining the operating expenses levied against you on a yearly basis. These expenses can include management fees paid right out of a fund's assets and distribution fees (or 12b-1 fees) that cover the expenses associated with marketing and selling the fund's shares.

  • The total annual fund operating expenses can be found on the fee table, and prudent investors use the expense ratio as a comparison among several potential funds.

Not everyone was born with a gift in mathematics. If the thought of calculating these numbers has you rethinking this whole venture into mutual funds, here's some good news. You can find mutual fund cost calculators online, and they'll help you analyze a mutual fund's expenses. There's a good one at the Financial Industry Regulatory Authority (or FINRA, for short) website.

At your disposal are several sources of information that you can use to evaluate a prospective new fund. The following documents should be available either on the fund's website, by contacting a broker that sells the fund, or by directly contacting the fund itself:

  • Profile: A fund's profile gives you a brief description of the fund, sums up the prospectus, and is a good starting point when narrowing your list of potential funds.

  • Prospectus: It's prudent to get your hands on a prospectus before you decide on the investment. The prospectus contains a wealth of information, including the fund's primary strategies, objectives, and core risks. It tells you who's in charge of the fund and how to buy and redeem shares.

  • Statement of Additional Information: Known as Part B of the registration, this document goes deeper into a fund's operations than the prospectus. It gives you details on the fund's history; includes fund policies on borrowing and concentration; identifies its officers, directors, and other information regarding tax matters; and offers performance and average total return information. To get this statement, consult the back cover of the prospectus.

  • Shareholder Reports: These regular reports give you up-to-date financial information and current holdings.

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