It has been a good year for exchange-traded funds focused on the oil-and-gas industry, though investors should be wary of potential pitfalls, analysts say.
There are many ETFs tracking the exploration-and-production sides of the oil-and-gas industry, investing in companies like Exxon Mobil Corp. (XOM) and ConocoPhillips (COP) and most have had a strong 2019 so far. The largest ETF in the area—the $13.6 billion Energy Select Sector SPDR Fund (XLE)—is up more than 16%, as is the $3.7 billion Vanguard Energy ETF (VDE), the second-largest fund. The $1 billion iShares Global Energy ETF (IXC), from BlackRock Inc.'s iShares unit, is up almost 15% year to date.
Cyclical sectors like energy that are tied to the health of the economy have powered this year’s stock rally, says Neena Mishra, director of ETF research at Zacks Investment Research. Additionally, this year's rally started from a low base, as oil-and-gas funds took a pummeling in the tough markets at the end of 2018. Energy equity ETFs provide a broad and diversified exposure for investors and are less volatile than oil commodity funds, which are more suited for shorter-term trading or hedging, Ms. Mishra says.
The sector's performance is largely driven by supply-side factors that have kept the price of oil relatively high, says Dhruv Nagrath, iShares investment strategist. For example, he points to OPEC's commitment to reduce production, which iShares expects to continue for the coming year.
Investors expecting higher oil prices might want to consider an allocation to ETFs that provide direct exposure to the commodity, says Matthew Bartolini, head of SPDR Americas Research at State Street Global Advisors. With the International Energy Agency forecasting that renewables will capture 65% of global investment in power through 2040, he also suggests investors take a look at ETFs focused on the renewables market.
“The shift toward a more renewable-driven world will have a direct impact on the traditional energy sector,” he says. As such, “a pure oil-and-gas ETF may not be the most optimal way to position for a cleaner-energy world.”
Among energy funds with narrower focuses, the $18.7 million American Energy Independence ETF (USAI) is up 23% this year. The fund focuses on midstream energy infrastructure, such as storage and transportation. The midstream sector as a whole, however, remains well below the highs of summer 2014, before the collapse in energy prices that year, says Simon Lack, managing partner of SL Advisors, which manages USAI. He thinks energy infrastructure funds could deliver annual returns in the low to midteens in the years ahead as the energy business continues to recover.
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