If you want to find a high-quality Canadian energy ETF to invest in, then you need to look at the stocks it holds, its liquidity, and more

High-quality energy stocks—or resource stocks, generally—can provide you with a hedge against inflation as well as other hidden benefits, if you make the right investment decisions. Energy producers do sometimes turn out to have hidden risks, such as environmental liabilities, but the top stocks in the industry also create their own hidden assets. Here are the factors smart investors should look for while researching a top Canadian energy ETF to invest in.

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6 Important considerations for picking a Canadian energy ETF:

1. Know how broad the ETF’s stock holdings are, so you can determine its volatility. The broader the ETF, the less volatility it may have. A sector-based ETF, like one that tracks resource stocks, may be more volatile.
2. Know the economic stability of countries that an international ETF invests in. It’s also worth mentioning that foreign leaders may not be your ally when it comes to passing laws or imposing regulations that can affect your investments
3. Know the liquidity of ETFs you invest in, look at the volume of shares that trade hands on a daily basis.
4. Consider buying ETFs in a lump sum rather than with periodic small amounts, so you can cut down on brokerage fees.
5. ETFs can be volatile, even with the diversification they offer.
6. Don’t invest in ETFs that show wide disparities between the stocks they hold and the investments that the sales literature describes. Despite the increased attention for ETFs, many ETF managers continue to describe their investing style in vague (or sometimes misleading) terms.

Find out what investors should look for in a Canadian energy ETF focused on oil and gas to add good picks to their portfolio

We think that most investors can maintain some exposure to the oil industry as part of the Resources segment of your portfolio.

Here are some factors for picking a top Canadian energy ETF focused on oil and gas:

1. Look at the market cap of the oil and gas exploration companies that the ETF holds versus the estimated value of the reserves they have in the ground. Sometimes, a company’s marketing efforts are so successful that they drive the stock up too high in relation to the size of their oil and gas findings. We like an exploration company’s market cap to be no more than half the value of the oil and gas in the ground.
2. Look for ETFs that invest in oil and gas energy companies that use innovative new drilling and exploration techniques. Staying ahead of the curve will keep them in business.
3. Look for oil and gas exploration companies that have cash flow from existing wells that is sufficient for, or at least contributes to, the development costs of additional wells.
4. Invest in oil and gas energy stocks that own diversified drilling sites in multiple geographic locations where exploration has been successful in the past.

Above all, when considering how to invest in oil stocks, resist the urge to go overboard, particularly in high-risk oil investments such as junior oils, futures, options and so on. They are as risky as ever, and they especially may fail to thrive in a slow oil recovery. Subscribe to our Best ETFs for Canadian Investors newsletter to see all of our top ETF picks.

Is it worth investing in a Canadian energy ETF that focuses on renewable energy?

A number of renewable energy ETFs have emerged as concerns over the environment have grown. However, among the funds holding top stocks in that segment, there are others with very limited investment appeal.

Many of those stocks are only profitable—if at all—because they receive government subsidies. But many governments around the world may cut subsidies for renewable energy investments as they look for ways to deal with their ballooning budget deficits because of COVID-19 spending.

Theme ETFs like renewable energy may have a lot of emotional appeal. But when you indulge in theme investing, you may assume that if you can just get on-board that theme or find an investment with its future tied to it, you are bound to make money.

In other words, you are buying what you might call a “Big Idea” without making certain that a particular investment has a workable business concept, or the management strength and integrity that it needs to overcome competition and profit from it.

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Themes like renewable energy ETFs can cause you to overlook crucial details. A key problem is that if the theme is your overriding investment consideration, it’s all too easy to get lazy about the details. You may feel that all the hard work has been done for you. You may come around to the view that the theme is so powerful that you can safely disregard p/e ratios and other measures of value and risk. You may wind up basing investment decisions on offhand projections or self-serving advice from promoters. That can distract you from looking at an ETF’s stocks and their fundamentals.

Do you find it more beneficial to your portfolio to invest in individual energy stocks or energy ETFs?

Have you invested in any theme ETFs? What kind of results did you get?