Q I’ve been thinking about incorporating exchange-traded funds (ETF) into my portfolio, but I’m concerned my taxes  might become even more complicated. Are there any special tax considerations with ETFs?—Bill Stryjzewski

A Although you should always consult a tax professional about your individual situation, ETFs are extremely tax efficient. In fact, ETF investors usually can expect a lower tax bill than those who hold open-end mutual funds.

Anyone who has invested in an open-end mutual fund knows that they get a 1099-DIV which breaks down the classification of the distributions they received throughout the year. They’re also familiar with paying both short-term and long-term capital gains taxes for trades the fund made throughout the year. It’s always tough having to pay someone else’s tax bill.

When you hold most ETFs (there are a few exceptions), you’ll receive a 1099-DIV as you would for any other stock or fund. But one of the first things you’ll notice is that there are rarely embedded capital gains taxes, and if there are any, they’re usually relatively small. That’s because ETFs exchange shares throughout the year with authorized participants on a tax lot-determined basis, minimizing capital gains.

There are two types of funds where taxes are handled a bit differently, though.

Under the current IRS rules, gains on those funds that hold physical gold are taxed at the current collectables rate of 28 percent.

The second exception is that some commodity-tracking ETFs are structured as partnerships and send out K-1s instead of 1099-DIVs. Although some investors find K-1s intimidating, they really aren’t that difficult to handle and can be imported directly into most of the popular tax preparation software packages.

Q In the October 2009 issue, you wrote about a few health care funds. I purchased shares of T. Rowe Price Health Sciences (PRHSX). The fund had been up more than 17 percent but recently took a tumble. Should I continue to hold?—Benjamin Hickey

A In that article we discussed T. Rowe Price Health Sciences (PRHSX), Fidelity Select Biotechnology (FBIOX) and Fidelity Select Pharmaceuticals (FPHAX). All three funds had posted nice gains until they sold off with the broader market in early May.

Although the funds aren’t totally immune to investor nerves, we still like all three funds and continue to recommend them for their defensive qualities. Health care has largely underpeformed the S&P 500 for the past year, as uncertainty about the shape of health care reform prompted many to shy away from the sector. Plus, many investors were underweight health care names in favor of growth stocks.

But this could be a rocky summer for the markets. Exposure to health care stocks provides a bit of portfolio insurance because all three funds have lower betas than the S&P 500. There’s also a strong possibility that choppy markets could push investors into more defensive fare—a potential boon for health care stocks.

Q When you recommended Schlumberger (NYSE: SLB), you cited two “investing experts” who claimed it was a $100 stock. My position is up a bit, but I’m worried that the oil spill in the Gulf of Mexico could prevent the shares from reaching their potential anytime soon. Eni (NYSE: E) is another dud. What’s the story with these stocks’ lack of energy?—Pete Weber

A We stand by our initial recommendation of Schlumberger: The oil-services giant should benefit over the long term as energy producers target more complex fields in the deepwater. In that regard, the firm’s geographic footprint, sterling reputation and diverse product lineup are a huge advantage.

Investors are leery of deepwater drilling in the wake of the disaster in the Gulf of Mexico. Schlumberger was only nominally involved in Macondo well and likely won’t face any liability for the accident. Nevertheless, the stream of negative news related to the spill overshadowed the firm’s first-quarter results.

Although Schlumberger’s revenue was down slightly from the previous quarter, management noted the strong performance of its North American segment and stated that international margins have already bottomed and are poised to trend higher. Management also noted improvements in key offshore markets and Russia.

As for Eni, the Greek sovereign debt crisis and questions about Italy’s fiscal health have weighed on European equities. A disruption to production at some of its Nigerian operations also sparked concern.

That being said, management continues to do an admirable job positioning the company for future growth.

Eni has a history of aggressively replacing maturing oil and gas acreage. Years ago when its legacy fields in Italy showed signs of declining output, the company expanded its upstream operations into North Africa, a region that now accounts for roughly a third of its production.

Eni’s management remains just as ambitious today, targeting average annual production growth of 3.5 percent during the next four years and a replacement rate of 130 percent.

And Eni continues to leverage its reputation to make discoveries and secure production in farflung areas that many of its peers avoid. We’re more inclined to invest in Eni based on its future than its present.

We’re always happy to receive subscriber comments and questions by e-mail at service@ rukeyser.com or by telephone at 800-832- 2330. Maybe your question will appear in our next issue!