Compared to the broader market, energy stocks weren’t the stocks to own last year. The Energy Select Sector SPDR (XLE) rose just 11.7%, including dividends paid, against a 31.2% gain for the S&P 500 (.SPX).
Also consider that the energy sector saw its weight within the S&P 500 dwindle to its lowest levels since the 1980’s. Dow component Exxon Mobil (XOM) dropped out of the top 10 S&P 500 names for the first time on record. That stock and rival Chevron (CVX) yield an average of 4.60%, making them two of the “dogs of the Dow” for 2020.
Increased adoption and falling costs for renewable energy sources coupled with the the persistent skewering of fossil fuel producers by the virtuous investing crowd, including some institutional investors, made for a perfect storm of difficulty for traditional energy equities last year.
There is some good news to consider with energy exchange-traded funds this year, including the sector’s status as a value destination, improving free cash flow among larger producers and an ongoing need for oil throughout the world.
For investors looking to bet on better things for the energy sector this year, here are some energy ETFs to consider.
Fidelity MSCI Energy Index ETF
Expense Ratio: 0.084%, or $8.40 annually per $10,000 invested
The Fidelity MSCI Energy Index ETF (FENY) is a solid idea for investors willing to make a long-term commitment to traditional energy names because the fund is the least expensive energy ETF on the market and is heavily allocated to higher quality fare, such as Exxon and Chevron.
Another reason to consider big-name energy stocks, particularly in basket form as offered by FENY, is that the group is becoming more committed to shareholder rewards, such as buybacks and dividends to support stagnant price appreciation.
“Energy stocks have been out of favor for the five-year period ending October 31, 2019. Energy has been the worst-performing of the 11 sectors in the S&P 500 during that time, with an annualized return of -4.95%, and the only sector with a negative return,” said Fidelity in a recent note. “Meanwhile, the S&P 500 index is up 10.78% per year over the same period. As a result, more energy companies have shifted attention from production to profitability and shareholder-friendly efforts, even amid historically low crude oil prices.”
Alerian Energy Infrastructure ETF
Expense Ratio: 0.65%
One part of the energy patch that’s showing some strength early this year is the midstream. The Alerian Energy Infrastructure ETF (ENFR) is higher by 2.5% and is proving to be a more reliable bet than more traditional energy ETFs. That comes after midstream equities were the top performers in the energy sector in 2019.
ENFR follows the Alerian Midstream Energy Select Index, one of the most widely followed midstream benchmarks. The midstream dedication is relevant at a time when those companies are working to reduce debt and burdensome incentive distribution rights (IDRs).
“Our long-term outlook for midstream oil and gas companies is unchanged, but we could change our fair value estimates depending on whether new and material investment projects are sanctioned in response,” said Morningstar in a recent note. “We think midstream companies that could benefit from higher demand for export infrastructure and related pipelines, wider differentials, and higher demand for liquefied natural gas, given oil-linked contracts.”
VanEck Vectors Energy Income ETF
Expense Ratio: 0.45%
The VanEck Vectors Energy Income ETF (EINC) is impressing on two fronts to start the new year. First, its 9.40% dividend is a whopper, even among energy ETFs designed to be income plays. Second, and more importantly, the fund is up 3% this month.
EINC targets the MVIS North America Energy Infrastructure Index, “which is intended to track the overall performance of North American companies involved in the midstream energy segment, which includes MLPs, and corporations involved in oil and gas storage and transportation,” according to VanEck.
Although they’re not integrated energy firms or energy and production companies, EINC components are levered to the growing U.S. energy export story.
“This significant growth in North American oil and gas production has increased the need for supporting infrastructure, including new pipelines connecting producing regions with demand centers and the coast for export,” said VanEck in a recent note. “A 2018 study by the Interstate Natural Gas Association of America estimated that an investment of $521 billion in midstream energy infrastructure is needed in the U.S. and Canada by 2035.”
iShares Global Energy ETF
Expense Ratio: 0.46%
The iShares Global Energy ETF (IXC) combines domestic oil giants, such as Exxon and Chevron, with international equivalents, including BP Plc (BP), Royal Dutch Shell (RDS/A) and France’s Total (TOT).
Not only does that give the fund some geographic diversity, it offers investors deeper value and higher dividends, two traits applicable to European oil majors. IXC’s ex-U.S. components offer some other benefits.
“One of their big draws: Many non-US energy companies tend to have higher exposure to high-growth prospect drilling regions such as the Middle East, Asia Pacific and Africa than their stateside brethren — not to mention that some are generous dividend payers, too,” reports OilPrice.com.
FlexShares Morningstar Global Upstream Natural Resources Index Fund
Expense Ratio: 0.46%
The FlexShares Morningstar Global Upstream Natural Resources Index Fund (GUNR) can augment midstream energy ETFs because this fund focuses on the upstream segment. However, GUNR isn’t a dedicated energy ETF. It also features exposure to materials and mining names, giving investors broader exposure to equities that can benefit from favorable commodities cycles.
GUNR reflects the value propositions offered by the energy and materials sectors as more than 44% of the fund’s holdings are classified as value stocks, more than triple its weight to equities with the growth designation. Another perk: GUNR devotes almost two-thirds of its roster to ex-U.S. stocks, giving it a yield of 3.22%, well in excess of the S&P 500.
Overall, GUNR is a compelling option for investors seeking a broad approach to real assets.
“[I]nvestors continue to benefit from innovation within a variety of investment vehicles that focus on real assets,” notes FlexShares. “Furthermore, strong demand for real assets is being met with an unprecedented supply of opportunities for investment, and we believe trends indicate that it will continue to grow. The Real Assets classification (e.g., timber, water, infrastructure, natural resources, etc.) is continually evolving, influenced not only by new asset types, but also regulatory and issuance changes.”
VanEck Vectors Oil Services ETF
Expense Ratio: 0.35%
The VanEck Vectors Oil Services ETF (OIH) is an energy ETF for risk tolerant investors because oil services stocks are usually intimately correlated to crude prices. Translation: OIH is a great place to be if oil prices are rising, but if crude prices are falling, this fund can sting its owners.
An issue facing oil services providers this year is lower spending forecasts by integrated oil companies and exploration and production firms in the face of low crude prices. A recent IHS Markit poll indicates global investors are comfortable betting on a “cyclical” rebound for energy stocks, a theme that if valid, should matriculate to oil services equities.
“Still, 67% of respondents believe that there is potential for the industry to experience a cyclical reversion in the stock market and come back into favor with equity investors,” according to the research firm. “They believe that a rotation back into the energy sector is contingent on the supply-demand balance, conservative capital strategies and an improving outlook for the global macro and trade tensions.”
Global X MLP ETF
Expense Ratio: 0.45%
The Global X MLP ETF (MLPA) is another option for investors looking to access the midstream, a compelling and undervalued area of the energy patch.
“Midstream is one of the most undervalued asset classes across the equity universe. And the strength of the cash flows and dividend coverage makes for a more positive asset class outlook in 2020,” according to Global X research.
Importantly, dividends in the midstream space have more than adequate coverage, a positive for investors looking to tap MLPA for added income.
“Dividend coverage ratios for the asset class are cushioned by 30% on average and price-to-cash flow valuations are trading at early-2016 levels of 5x when oil prices were hitting rock bottom,” said Global X.
As of this writing, Todd Shriber did not own any of the aforementioned securities.
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