Weigh Your Options With Energy ETFs, Part 2

As covered in the first part of this series on energy exchange-traded funds, experts recommend that investors assess their investment priorities and analyze fund manager tactics before settling on an investment choice.

Ron Delegge, publisher of ETFguide.com, says that investors must decide whether they are looking for a fundamental building block for their portfolio, if they want exposure to a specific niche within a larger space or if they're pinning their hopes on the decision-making skills of a particular portfolio manager.

Jeffrey Ptak, ETF analyst at Morningstar, says that the focused ETFs are riskier investments than the broader, diversified funds, primarily because they haven't been around as long. For example, the Vanguard Energy ETF VDE, a diversified ETF that is highly favored by many analysts, has generated consistent and dependable returns since its inception in September 2004, whereas the Market Vectors Coal ETF KOL has only been around since January.

"The proof is still in the pudding," Ptak says. "So far, nobody in the niche ETF space has built a better mousetrap than the broader diversified vehicles."

That's not to say that there aren't niche energy ETFs with strong performance records. However, investors who buy into these funds should understand the inherent risks and treat those holdings accordingly.

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Up first is the PowerShares DB Commodity Index Tracking FundDBC, a security that tracks the Deutsche Bank Liquid Commodity Index. It uses an investment screen to take positions in commodity futures contracts and holds a fixed-weight ratio of holdings. Its holdings include futures contracts in light, sweet crude oil, heating oil, aluminum, gold, corn and wheat. The fund's expense ratio is 0.75%.

PowerShares DB Commodity Index Tracking Fund sports a one-month yield of 1.6%, a year-to-date yield of 14.23% and a one-year return of 48.7%. While it's broadly exposed to commodities, it is a nondiversified portfolio. The fund's managers are seeking a return above and beyond what a diversified commodity fund would provide. Its results are impressive, but it has only been operating since January 2007.

Next is the MACROshares Oil Up Tradeable Shares UCR, a fund built to track upward price movements in futures contracts for West Texas intermediate crude. It is a nondiversified fund that invests in WTI futures contracts. It has been operational since November 2006, and its expense ratio is 0.5%.

This fund is not for investors who simply want exposure to crude oil. Rather, it is a vehicle that is making big bets that crude prices are going higher. Looking at how crude prices have doubled since January 2007, taking the long bet on crude prices appears to make some sense. Still, the crude market has been extremely volatile throughout the last 15 months -- 5% moves up or down in a day are not uncommon. Thus, investors who buy into MACROshares Oil Up Tradeable Shares must be prepared for this volatility.

The fund has returned 7.6% in the past month, but negative 5.7% in 2008. In the last year, it's up 26.2%.

Last is the PowerShares DB OilDBO, which invests in WTI futures contracts and is intended to generate returns that exceed those of a diversified oil futures fund. The fund holds a fixed-weight ratio of holdings, and its expense ratio is 0.75%, which is slightly higher than the category average of 0.71%. The fund has been trading since January 2007.

As with PowerShares DB Commodity Index Tracking Fund, this PowerShares fund has increased exposure to the volatility and growth potential of the commodity it tracks because of the fund's investment strategy. The fund has a one-month yield of 4.59%, a three-month return of 11.8% and a one-year gain of nearly 52%.