2 Energy Funds Being Fueled by Oil's Rally

It's just two weeks into summer and gas prices are already on the rise. The price of a barrel of oil surged to a recent $71, an almost 70% jump since bottoming out earlier this year, and rekindled talk that it could approach the $150 mark it flirted with mid-2008. No doubt, that will eventually translate into even higher prices at the gas pump just as Americans prepare to head out on vacation.

Blame oil's dramatic rise on inflation fears. Investors are worried that the trillions of dollars the government is spending in bailouts and other initiatives will weaken the U.S. dollar and boost inflation over the next few years. Dollar-denominated commodities like oil have historically been good hedges against inflation since their prices increase as the dollar weakens.

Oil is also being propped up by hopes that a global economic recovery is underway. On Thursday, the International Energy Agency revised upward its 2009 global demand forecast, the first time it had done so in 10 months. Of course, oil's increase can also be partly blamed on speculators who artificially move oil prices even when the fundamentals don't support the price.

"Oil may be overbought right now, but there is the potential to see heavy inflation," says Steven Stahler, president of financial advisory firm Stahler Group in Baton Rouge, La. Over the long term, he says, oil will be "somewhere between where we are now and $100."

Oil's rally is putting the energy sector back in the spotlight. Lipper's natural resources fund category is up 29.3% this year through Thursday vs. a 5.8% increase for the typical S&P 500 index fund. It's been a while since we turned our attention to energy, and it seems like a good time to revisit this sector as oil prices climb. There are just 48 funds in this category, one of the smallest groups we start with all year. We narrowed that universe to 11 funds after excluding funds that charge sales loads. We then searched for funds with top-tier long-term track records and low fees. Once that search was complete, we were left with just two funds, Columbia Energy & Natural Resources (UMESX) and ICON Energy (ICENX). Those are the same two funds that made our list the last time and they haven’t disappointed us since then.

Despite the narrow selection of funds that invest in the energy sector, the industry is incredibly diverse. It encompasses physical commodities such as oil, natural gas and gasoline, as well as the drillers and equipment makers that get those products out of the ground and the conglomerates that refine it and sell the end products to consumers and businesses. The sector also includes the emerging alternative energy industry, including solar and wind power.

The typical S&P 500 index fund allocates about 13% of its portfolio to energy, which is plenty for most investors. But those who want to make more calculated bets can always buy individual securities like Exxon Mobil (XOM), which recently hit $73 a share, an almost 20% gain from its March low, or invest in exchange-traded funds that track a particular group of stocks. Stahler likes high-yielding, tax-friendly master limited partnerships that focus on things like natural gas pipelines. (Claymore has a fund (FMO) that invests in a basket of MLPs.) State Street's SPDR ETF family has offerings that track equipment makers (XES), exploration & production companies (XOP) and the broad sector (XLE). Claymore and Market Vectors offer solar energy funds and the United States Oil ETF (USO) offers exposure to black gold.

Of course, typical investors don't have the time or expertise to understand the ins and outs of a master limited partnership or trading energy ETFs. If you are considering overweighting your portfolio toward energy it would pay to first see a financial advisor like Stahler. Another option is to use an actively-managed mutual fund like the ones listed below. A word of caution: The sector can be volatile and as we said before, most investors already have plenty of exposure through a plain-vanilla index fund.

The Criteria: The natural resources funds below are open to new money, require a minimum investment of under $5,000 and charge an annual expense ratio under 1.5%. They have track records that put them in the top 40% of their category over the trailing three- and five-year periods. They're also beating the S&P 500 on a year-to-date basis. As usual, we did not include load funds.