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Rob Carrick

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Too hot to handle?

Rob Carrick

 

OTTAWA (globefundGOLD) - Introducing a pair of oven mitts for investors who think energy stocks are too hot to handle.

You won't receive all the benefits of a blazing-hot oil and gas sector if you buy exchange-traded funds and index mutual funds based on the two major Canadian stock indexes, the S&P/TSX composite and S&P/TSX 60. But there's compensation. If the energy sector melts down, you'll have a measure of protection through the exposure that both these indexes have to other sectors of the stock market.

Investing in an S&P/TSX composite fund gives you 28-per-cent exposure to energy stocks these days through market heavyweights like EnCana, Canadian Natural Resources, Suncor and Petro-Canada, as well as smaller stocks and energy trusts. If you want lighter exposure to energy, try the S&P/TSX 60 index of behemoth blue chip companies. The oil and gas weighting here is about 22 per cent.

A weighting of 28 per cent or 22 per cent in energy stocks might sound superficial, but it's significant enough to explain in large part why Canadian stock markets have been so hot over the past couple of years. Both the S&P/TSX composite and 60 indexes are up a cumulative 72 per cent or so in the past three years, compared to 47 per cent for the S&P 500 and 32 per cent for the Dow Jones Industrial Average. Both these U.S. indexes have far fewer energy stocks than the two benchmark Canadian indexes.

There's no question that a major pullback in oil prices would hurt both Canadian indexes. But the pain would be considerably lighter than if you owned individual energy stocks, energy ETFs or natural resource mutual funds. One reason is that ever-popular financial stocks are so dominant in both indexes. Banks, insurers and investment companies aren't immune to downturns (just ask shareholders of Canadian Imperial Bank of Commerce), but the broad sector is one of the steadiest in the Canadian market. Most of these stocks are attractive dividend plays, which helps maintain investor interest.

The Big Six banks alone account for almost 25 per cent of the S&P/TSX 60 index, so you've completely offset your energy exposure with trusty bank stocks. As well, you've got exposure to gold and mining stocks, many of which are hot right now, plus stable sectors like consumer staples, utilities and telecommunications.

The best way to buy the indexes is through a pair of exchange-traded funds, the iUnits S&P/TSX 60 Index Fund (XIU) and the iUnits Composite Canadian Equity Index Fund (XIC). The pair have ultra-low management expense ratios of 0.17 per cent and 0.25 per cent, respectively, so you're in line to make very close to what the index makes. The only catch is that you need a brokerage account, as ETFs like these trade like stocks.

If you're strictly a mutual funds investor, then take a look at index mutual funds. With much higher MERs than ETFs, these funds are a decided second-best option for index investing. But they do have accessibility on their side because they're available from virtually all bank fund families, as well as the no-load fund company Altamira Investment Services.

For the S&P/TSX 60 index, try the Altamira Precision Canadian Index Fund, with an MER of 0.53 per cent and a minimum investment of $1,000. If you can't buy the iUnits S&P/TSX 60 Index Fund, this fund is your next best option. For exposure to the S&P/TSX composite, the top choice is the e-version of TD Canadian Index, which is available only on-line from Toronto-Dominion Bank or its discount brokerage, TD Waterhouse. The MER for this fund is a very reasonable 0.31 per cent, and the minimum investment is $1,000. The cheapest S&P/TSX composite index fund available through traditional fund sales channels is RBC Canadian Index, with an MER of 0.78 per cent and a minimum investment of $2,500.

When oil and gas prices are soaring, these index funds and ETFs won't throw off the same heat as a direct holding in energy stocks or funds. But given how long the energy rally has run, and the fact that energy has traditionally been a cyclical sector with big ups and downs, this could be a blessing in disguise.

Rob Carrick has been writing about personal finance, business and economics for more than 12 years.

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