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Time for This Top Ranked Energy ETF?

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Rapidly emerging from a massive setback in 2012, the U.S. energy sector is geared up to be one of the top performers in 2013 given its strong fundamentals and low valuations (Read: (5 Sector ETFs Surging to Start 2013).

The energy ETFs were in the red for most of 2012, mainly due to a sluggish oil market, but these funds began to bounce back from the latter part of the year, and we expect this wining momentum to continue for the rest of 2013.

Since the pulse of the energy sector is closely tied to the swings in the macro economy, the improvement in the U.S. economy should trigger energy consumption. While the recent strengthening of the U.S. dollar will likely affect oil prices, rising U.S. oil production and greater energy conservation should be sufficient to mitigate price losses due to currency headwinds.  

The surge in the energy sector is mainly due to a rise in U.S. oil production which is limiting the nation’s net oil imports. The U.S., which is the largest consumer of oil, has seen growth in energy production by leaps and bounds. The million barrel-per-day jump in oil production was the biggest increase globally in 2012, and a record single-year increase in the country’s history.

Also, the current boom in oil production shows little sign of waning thereby strengthening the sector for the long term. In fact, by 2035, the U.S. is expected to be “energy independent” and start exporting natural gas by the end of this decade (Read: 3 Energy ETFs for America's Production Boom).

This pumped optimism into the energy stocks and consequently the ETFs since the start of 2013 (Read: Time to Buy Energy ETFs?). According to the Energy Information Administration (EIA), which provides official energy statistics from the U.S. government, world liquid fuel consumption grew an estimated 0.7 million barrels per day in 2012 to a record-high level of 89.0 million barrels per day. The companies engaged in the drilling and extraction of oil were the major beneficiaries of the trend.

The bullish fundamentals make it important to find a top ranked pick in this segment. In order to do this, investors can look at the Zacks ETF Rank and find the top energy ETF.

About the Zacks ETF Rank

The Zacks ETF Rank provides a recommendation for the ETF in the context of our outlook for the underlying industry, sector, style box or asset class (Read: Zacks ETF Rank Guide). Our proprietary methodology also takes into account the risk preferences of investors. ETFs are ranked on a scale of 1 (Strong Buy) to 5 (Strong Sell) while these also receive one of the three risk ratings, namely Low, Medium or High.

The aim of our models is to select the best ETF within each risk category. We assign each ETF one of the five ranks within each risk bucket. Thus, the Zacks Rank reflects the expected return of an ETF relative to other products with a similar level of risk (see more in the Zacks ETF Center).

For investors seeking to apply this methodology to their portfolio in the Energy sector, we have taken a closer look at the top ranked PXI. This ETF, with a Zacks ETF Rank of 1 or ‘Strong Buy’ (see the full list of top ranked ETFs), is detailed below:

PowerShares Dynamic Energy Fund (PXI) in Focus

Launched in October 2006, the PowerShares Dynamic Energy Fund (PXI - Free Report) – is an ETF designed to provide broad exposure to the US energy sector. PXI tracks the Dynamic Energy Sector Intellidex Index, and has amassed a net asset base of $132.0 million.

Holding 60 stocks in its basket, the fund is well diversified across individual securities as it puts nearly equal weight on each holding. The product puts just about 25.7% of its total assets in the top 10 holdings, suggesting lower concentration risk (read: Alternative ETF Weighting Methodologies 101).

Noble Energy Inc. (NBL - Free Report) , EOG Resources Inc. (EOG) and Halliburton Co (HAL - Free Report) are its top three holdings with a respective weight of 2.68%, 2.63% and 2.60%. However, this choice is a bit pricey in the U.S. energy space with around 66 bps of annual fees.

Its daily trading volume of 31,000 is also lower than the many other choices. Basically, more ‘active’ funds like PXI seek to beat out traditional indexes. This approach results in relatively higher fees and turnover than the simpler funds in the space.

Capitalization-wise, the fund is almost uniformly distributed with a large cap focus of 40% followed by a small cap and mid cap focus of 38% and 22%, respectively. Style-wise also, the fund structure calls for uniformity among value and growth funds. The strategy of adopting equality in stock selection for each and every parameter makes this fund a low-risk opportunity and a better hedging instrument.

PXI started the year 2013 on a solid note, like many other energy funds. Over the last one-year period, the return from PXI (32.65%) massively outperformed the S&P/ TSX Capped energy index (10.6%). Its return beat some of the category behemoths including SPDR Energy Select Sector Fund (XLE - Free Report) Vanguard Energy ETF (VDE - Free Report) and iShares Dow Jones US Energy ETF (IYE) as well during the time period.

Bottom Line

So far, the product has been relatively unappreciated as evident by its lower trading volume. The fund is currently hovering below its 52-week high price and given its potential, could continue to appreciate in the months ahead as well.

So if current trends continue in the market, PXI could prove to be an intriguing option for investors to play the energy boom this year, especially while maintaining a focus on the domestic market.

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