Time To Consider The Small Cap Oil ETF (IOIL) - Commodity ETFs
December 12 2011 - 4:17AM
Zacks
Pretty much every investor, regardless of focus, has heavy
exposure to major oil companies such as ExxonMobil (XOM) or Chevron
(CVX). These energy behemoths dominate cap-weighted indexes that
many ETFs are based on and they also occupy a large share of assets
in mutual funds as well. Luckily for many investors, these
companies have done quite well over the years and seem poised to
continue to dominate thanks to the slow adoption of alternative
fuels and the rapid expansion of emerging markets that need cheap
fuel to continue their incredible growth.
While these securities have been world-class investments for
quite some time, some are beginning to grow worried that their
reign over the market is nearing an end. In addition to concerns
over increased regulation, taxes, and clean energy, the firms are
beginning to finally experience heavy competition from their
counterparts in emerging markets. These companies, often times with
the backing of their governments, are able to thoroughly control a
particular nation, potentially squeezing out companies that are
more investor focused and Western-based (read Top Three High Yield
Real Estate ETFs).
This is especially the case for state-owned (or at least
partially state-owned) firms such as Petrobras (PBR), CNOOC (CEO),
and Petronas which ensure that their home countries remain more or
less off limits to Western oil interests. In fact, when looking at
worldwide reserves allocated to each company, not a single
investor-owned firm is in the top 10 and ExxonMobil, Chevron, Total
(TOT), and BP, combine to hold just over 2% of total world
reserves. Thanks to this reality, investors now have two options;
try their luck at partially state-owned firms such as Petrobras, or
look to small cap securities instead.
Small caps could potentially be an excellent choice in the oil
market for a few reasons. First, few investors have exposure to the
space, as these securities are often absent from broader portfolios
for all but the most diversified of investors. Furthermore, many
small cap oil companies, much like their counterparts in the
biotech/pharma space, have high quality assets that could make them
potential takeover targets by their large cap peers. This could
especially become the case if these large caps grow increasingly
desperate to expand their production capabilities and even more so
if emerging oil companies continue to leave Western firms on the
outside looking in. This could be a trend in the near future as
many oil firms have developed incredible cash balances that will
need to be deployed at some point. A recent look at these reserves
suggests that TOT, XOM, and CVX combine to have more than $50
billion in cash on their books, enough to buy a company the size of
Devon Energy twice over (Three Outperforming Active ETFs).
IOIL In Focus
For investors seeking broad sector exposure to this space,
IndexIQ’s IQ Global Oil Small Cap ETF (IOIL) could make for an
interesting choice. The fund tracks, before fees and expenses, to
the price and yield performance of the IQ Global Oil Small Cap
Index. The benchmark provides exposure to global small cap
companies engaged in the oil sector, including in the areas of
exploration and production, refining and marketing, and equipment,
services and drilling (also see Three Low Beta Sector ETFs).
IOIL holds about 60 securities in total, with exposure roughly
split down the middle between U.S. and international securities.
The fund is slightly skewed towards refining and marketing
companies although, exploration, and equipment firms also receive
sizable chunks as well. In terms of individual securities, the
Dutch company Core Laboratories (CLB) takes the top spot but it is
closely trailed by Oceaneering International (OII) and
HollyFrontier (HFC)
While the fund may have an interesting holdings breakdown, there
are a few downsides that investors should be aware of. First, like
most small cap-focused ETFs, the fund is more expensive than its
large cap peers, charging 75 basis points a year in fees. Investors
should also note that the product has failed to attract a
meaningful number of assets so far and average volume is below
5,000 shares a day while the underlying holdings aren’t the most
liquid either. This could result in significant bid/ask spreads
which could increase the total cost of investing in the fund (see
ETFs vs. Mutual Funds).
Nevertheless, for investors with a longer-term focus, the
product could make for an excellent pick. The fundamentals of the
oil industry are pretty strong and the small cap space could see a
surge in interest if their larger cap counterparts get desperate
for more resources and opportunities in the near future. Thanks to
this, IOIL, if one can get by the low trading volumes and high
fees, could be a quality choice as a satellite holding in a
well-diversified portfolio.
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BP PLC (BP): Free Stock Analysis Report
CNOOC LTD ADR (CEO): Free Stock Analysis Report
CORE LABS NV (CLB): Free Stock Analysis Report
CHEVRON CORP (CVX): Free Stock Analysis Report
HOLLYFRONTIER (HFC): Free Stock Analysis Report
OCEANEERING INT (OII): Free Stock Analysis Report
PETROBRAS-ADR C (PBR): Free Stock Analysis Report
TOTAL FINA SA (TOT): Free Stock Analysis Report
EXXON MOBIL CRP (XOM): Free Stock Analysis Report
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