Twenty years ago, who’d have thought America would ever be anywhere near achieving energy independence? Back then, the majority of our fuel was imported, and the prevailing concern was the U.S. would always have to rely on foreign oil to meet its ever-growing energy needs.#-ad_banner-#

Boy, have things changed. Now people are talking about America’s energy boom.

According to the U.S. Energy Department, domestic oil production is reaching highs not seen since 1970 and should rise by around 800,000 barrels per day through 2016. Just this past October, the U.S. began producing more oil than it imports for the first time in nearly two decades. What’s more, domestic natural gas production is projected to climb 56% between 2012 and 2040, from 24.1 trillion cubic feet to 37.6 trillion.

According to the International Energy Agency, the U.S. will overtake Saudi Arabia as the world’s top oil producer by 2015. It’s already No. 1 in natural gas production.

Clearly, something huge is afoot on the domestic energy front.

But before I say anything further, let me acknowledge the controversy around hydraulic fracturing (aka fracking), the relatively new drilling method that has enabled energy companies to extract previously unreachable reserves of oil and gas. Without fracking, America’s energy boom may never have gotten off the ground.

I’m not here to judge. I just want to tell you about an investment that may well be the best play on the domestic energy boom. This investment has outperformed the broader market for the past five years, delivering 21.3% annually versus 15.2% for the S&P 500.

It has done so well by tracking an index of leading U.S. energy companies, many of which rely on fracking to produce oil and/or natural gas. I’m referring to PowerShares Dynamic Energy (NYSE: PXI), a sector exchange-traded fund (ETF) that’s in the top 1% of the equity energy category.

PXI tracks the Dynamic Energy Sector Intellidex Index, which is made up of 60 energy companies, primarily domestic, with market capitalizations ranging from about $640 million to $116 billion. Right now there are only three large foreign companies in the index: Swiss firms Transocean (NYSE: RIG) and Weatherford International (NYSE: WFT), and Netherlands-based Core Laboratories (NYSE: CLB).

If you scan the holdings list, you’ll see all of the top names associated with America’s energy boom, like Chesapeake Energy (NYSE: CHK), Occidental Petroleum (NYSE: OXY), and EOG Resources (NYSE: EOG), to name a few. PowerShares evaluates and rebalances the index quarterly, including only those companies that meet strict criteria for price and earnings momentum, the ability of management, and overall value. A company can be included in the index if it engages in oil and gas exploration or production, provides oil services or equipment, or is involved in other areas of energy production such as wind or solar.

The 10 largest holdings, which account for about a quarter of total assets, are listed below. Virtually all are involved in fracking to some degree.

Top 10 Holdings for PXI
 

One thing that’s not apparent from the table is PXI’s higher degree of diversification among companies of different sizes. PXI’s holdings comprise about 39% large-cap stocks, 29% mid-caps and 32% small- and micro-cap, compared with category averages of 46%, 41% and 13%, respectively. 

This significantly greater exposure to small and micro-cap stocks is another key advantage for long-term investors because these faster-growing stocks typically outperform larger ones over long periods. This greater focus on smaller companies hasn’t increased risk, however, as PXI is actually a bit less volatile than the typical fund of its type.

PXI has a reasonable expense ratio of 0.66%, but its yield is a meager 0.75%, making the fund unsuitable for income investors.

Risks to Consider: Although PXI provides broad exposure to companies at the forefront of America’s energy boom, it’s still a sector fund focused on the highly volatile energy arena. Expect share prices to vary greatly in the short term. A trend toward declining energy prices could significantly hinder fund performance in the longer term. 

Action to Take –> If you want to profit from America’s growing energy independence, consider buying shares of PXI. The fund is well-diversified but not to the extent that returns are watered down. What’s more, shareholders get the best names in the energy sector without having to make their own picks, reducing the risk of getting burned in a sector where the fortunes of individual companies can quickly turn sour at any time.

P.S. PXI is a great investment to buy and hold for a long time, but we know its dividend yield won’t be enough for yield-hungry investors… That’s why we put together a special report on a fast-growing oil stock with a 10.2% annual yield. In the past year, this company has quadrupled production to 4,000 barrels of oil a day. To learn more about why we like this company, click here to read the report.