How Risky Is Vanguard Energy ETF?

By Markets Fool.com

Do you want to invest in an oil or natural gas exchange traded fund? Are you confused by the number of oil and natural gas ETFs out there, and don't know which one to pick? According to the folks at ETFdb.com, the Vanguard Energy ETF (NYSEMKT: VDE) is one of the top three favorite energy ETF picks among analysts today.

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VDE is also one of the biggest oil ETFs, and with a year-to-date return of 21.5%, it's one of the most profitable stocks you could have in your portfolio this year. That said, VDE is not without its risks. Here are a few things you should know about it before buying in.


Bright lights, big refinery. Vanguard's Energy ETF loves oil and natural gas. Image source: Getty Images.

Cheaper is better

One of the reasons investors have profited so much by buying the Vanguard Energy ETF is because its managers don't take a lot of money off the top.Kiplinger magazine ranks it among the least expensive energy ETFs you can buy, with its annual expense ratio at just 0.10%.

Other energy ETFs sport expense ratios up to eight times as much. But with the Vanguard Energy ETF, you'll pay just $0.10 in annual fees for every $100 you invest in VDE.

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And diversified is also good

VDE is passively managed, seeking "to track the performance of a benchmark index that measures the investment return of stocks in the energy sector," says Vanguard. This energy ETF is also widely diversified -- at least from one perspective -- with $4.7 billion in total assets invested across 133 differentenergy stocks.

That said, VDE is not quite as diverse as it appears at first glance. Let's take a look at the top three VDE holdings:

ExxonMobil

Chevron Corp.

Schlumberger

Stock ticker

NYSE: XOM

NYSE: CVX

NYSE: SLB

% of VDE's holdings

21.8%

13.1%

7.3%

Market cap

$356 billion

$204 billion

$113 billion

P/E ratio

40.2

N/A

N/A

Data source: Yahoo! Finance.

Because the Vanguard Energy ETF invests in energy companies in proportion to their market capitalization, the bulk of the ETF's money ends up invested in just a very few, very large-cap companies.

As Vanguard explains, more than 36% of VDE is invested in just ExxonMobil (NYSE: XOM) stock and Chevron (NYSE: CVX) alone. Add in funds invested in oilfield services specialist Schlumberger (NYSE: SLB), and more than 43% of the ETF's assets are sunk into just these three stocks. For an investor in the Vanguard Energy ETF, this means if anything goes wrong with just one of these three stocks, the consequences for an investment in VDE could be pretty dire -- and right now, two of the ETF's three top holdings aren't earning a profit.

More diversified might be best of all

All of the above information is, of course, readily available on Vanguard's website. An investor buying into the Vanguard Energy ETF, therefore, shouldn't be surprised to learn that this oil and natural gas ETF owns a lot of leading oil and natural gas stocks.

But here's something that may surprise you:For an ETF that bills itself as a generic energy ETF, VDE doesn't really own a lot of stock in companies producing energy from stuff other than oil and natural gas. In fact, if you tally up all the percentages of its assets that Vanguard Energy ETF says it has invested in:

  • Integrated oil and gas -- 38.6%
  • Oil and gas exploration and production -- 27.3%
  • Oil and gas equipment and services -- 15.5%
  • Oil and gas storage and transportation -- 8.4%
  • Oil and gas refining and marketing -- 8.1%
  • Oil and gas drilling -- 1.8%
  • Coal and consumable fuels -- 0.3%

What you'll find is that these numbers tally exactly to 100%, which leaves no room whatsoever for investments in wind energy or in solar power -- two of the fastest-growing energy industries in the U.S. this year. It leaves no room for investments in nuclear stocks, or in biofuel, hydropower, or geothermal energy either. Instead, Vanguard's Energy ETF invests in just one thing: dinosaur juice.

Now, that may be just what you're looking for -- and if so, well and good. (In fact, with its 21.5% year-to-date return, maybe more than good!) However, if you were looking to buy into an energy ETF representing a more comprehensive picture of all the types of energy production available here in the 21st century -- not just oil and natural gas, with a dash of coal -- you may want to look elsewhere.

Speaking of which, one great place to start such a search might be Vanguard's Utilities ETF (NYSEMKT: VPU), which invests in electric companies that own and operate such alternative energy technologies. Read more about the Vanguard Utilities ETF here.

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