Amid a fair bit of hype, Van Eck issued the long-awaited Market Vectors Coal ETF ( KOL) this week.

The fund provides exposure to a segment of the market with compelling long-term supply and demand fundamentals. But it is also potentially volatile. Keep that in mind as I dissect it below.

Van Eck has developed an interesting stable of products that are narrowly focused on sectors that do not seem to be covered by other ETF providers. Its willingness to take risk has produced some very successful funds.

New Coal ETF Gets Fired Up

Since KOL listed, I have read and heard several interesting facts about coal that help support the long-term fundamental case. Coal is cheaper than oil and, according to the World Coal Institute , it supplies 40% of the world's electricity. China, by some counts, is breaking ground on a new coal plant every week.

There is not enough oil to fuel China's burgeoning demand for energy. Coal is more abundant and so by necessity China will use more of it to keep up with energy demand.

The drawback of course is that coal is dirty, toxic stuff. As consumption rises, you can expect some fallout in terms of possible litigation or negative sentiment that hurts the stocks of companies in this industry. Kind of like cigarettes, though, I think the global demand will win out over negatives over the long term.

The composition of the fund, similar to most of the Market Vectors products, strikes me as very aggressive; it provide access to where it's really happening in coal, so to speak. While the fund's biggest weighting is in the U.S., at 39%, it also has a 24% weighting in China and 11% in Indonesia. That could add to volatility if the road for those two countries gets bumpier.

Specifically, China Coal Energy is the largest holding at 8.13%, the third-largest is Indonesian miner Bumi Resources, at 7.96%, and the fifth is China's Shenhua Energy, at 7.83%. I mention these to underscore that the fund will very likely feel any market dislocations emanating from Asia.

The fact that the fund is vulnerable to Asia is neither good nor bad, but you need to take it into account. When you construct a portfolio with many different products like this you can end up with more China exposure than you originally intended. You end up with lopsided bets. Again, this is not about the funds but how they are used.

KOL's expense ratio will be 0.65%, it should yield 0.75% and its modified market-cap weighting favors large-cap stocks. The subsector breakdown puts 73% of assets in mining and production, 15% in coal power generation, 9% in mining equipment and 2.3% in technology.

A Volatile Mix
KOL's benchmark index is subject to even bigger swings than the Amex Energy Index
Click here for larger image.
Source: Van Eck

The above chart of KOL's back-tested results underscores how volatile it could be. In fact Van Eck reports the beta as being 1.71, compared with 1.00 for the S&P 500. The back test has performed well relative to the energy sector, but notice that from April 2006 to September 2006, the fund's benchmark index had a vicious correction that was far worse than the Amex Energy Index. The next time energy stocks catch a cold we may see KOL again get the flu, fundamentals notwithstanding.

I am favorably disposed to the concept, but the idea of the fund getting the flu rings very true to me. Anyone holding KOL for part of their energy exposure should consider offsetting some of the volatility with a more staid holding.
At the time of publication, Nusbaum had no positions in any of the securities discussed in this article, although positions may change at any time.

Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback; click here to send him an email.