The Energy Select Sector SPDR exchange-traded fund (ticker: XLE) is synonymous with energy stocks. The ubiquitous ETF is used as a proxy for the sector, primarily because most investors have heard of it … and many of them own it.
The XLE is the largest energy-focused exchange-traded fund on the market right now, and it’s not even close. XLE’s $17.3 billion in net assets under management is about $7 billion greater than the next-closest fund, the Alerian MLP ETF ( AMLP).
But in the current energy environment, is XLE the right energy-focused ETF to buy?
[See: The Best Energy Stocks to Buy for 2017.]
Energy outlook. Few experts entered 2017 expecting a renaissance in oil prices, but broadly speaking, many thought the environment would at least be better than last year:
— The U.S. Energy Information Administration in January forecast average West Texas Intermediate (WTI) prices of $52.50 per barrel, up from an average of $43.33 across 2016, though not much higher than where WTI traded near the end of December 2016. Similarly, while Brent crude averaged $43.74 last year, the forecast of $53.50 per barrel for 2017 wasn’t much higher than December levels.
— IHS Global Insight’s forecast from January wasn’t far off the government’s view, projecting a $53.20 per barrel average for WTI this year.
— Consensus Economics split the middle, looking for $52.97 per barrel.
— Natural gas was much the same, with the EIA projecting Henry Hub Spot prices of $3.55 per million Btu — up significantly from last year’s $2.60 average, but near end-of-2016 pricing.
Jay Hatfield, portfolio manager of the InfraCap MLP ETF ( AMZA), says his firm is bullish on oil prices in 2017. Global demand growth, a decline in high-cost offshore and tar sands production and reduced OPEC production should work in favor of higher demand/lower supply by about 3 million barrels per day, and will offset by increases in U.S. shale production by almost 1 million barrels from 2016’s lows.
“The net result of these four factors is the market is likely to be in balance or in slight shortage, causing inventories to decline and prices to trade in the $50 to $70 range during 2017,” Hatfield says.
Yet “energy has been one of the lagging sectors to start off 2017 as flattening oil prices hamper growth,” says David Fabian, managing partner and chief operations officer of FMD Capital Management in Irvine, California. Indeed, the XLE is down 5 percent so far this year against a strong market that has the Standard & Poor’s 500 index up nearly 6 percent in 2017.
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U.S. production is near a one-year high, and active oil rigs continue to inch higher, helping to keep oil trading in a tight range the past couple months. And while President Donald Trump has sworn his allegiance to U.S. energy, his policies ultimately are about growing U.S. energy jobs, which in turn means boosting U.S. energy production — a hindrance to the sector, and a reason why energy really hasn’t joined the “Trump Bump” in 2017.
Despite this iffy energy outlook, the XLE still could be a strong holding in 2017 and beyond.
Why invest in the XLE? The XLE is a relatively tight sector fund of 38 S&P 500 energy holdings representing a who’s who of blue-chip oil, gas and related stocks. Roughly 80 percent of the fund is invested in companies that develop, produce or transport oil, gas or other consumable fuels — the likes of Exxon Mobil Corp. ( XOM) and Kinder Morgan ( KMI). The remainder is dedicated to equipment and services stocks such as Schlumberger NV ( SLB) and Halliburton Co. ( HAL).
“If you’re looking for the total fossil fuel package, the XLE is your ETF,” says Aaron Levitt, a financial journalist who writes about energy for ETFdb.com and InvestorPlace.com. “The combination of up-, mid- and downstream names makes it a powerful choice for any oil or natural gas price environment. When you add in its low costs of ownership — thanks to its rock-bottom expense ratio and low bid/ask spreads — its appeal is even greater.”
The 0.14 percent in annual fees puts XLE among the lowest-cost ways to invest in the space.
XLE is market-cap weighted, and thus energy titans XOM ($335 billion market cap) and Chevron Corp. ( CVX, $210 billion market cap) account for nearly 30 percent of the fund’s weight. That looks particularly problematic right now, Hatfield says.
“Our models show those companies being overvalued relative to pure refiners or some pure E&P companies,” he says.
[Read: Is Now a Good Time to Invest in Energy Stocks?]
Instead, Hatfield points investors to the SPDR S&P Oil & Gas Exploration & Production ETF ( XOP), which is equally weighted, which means stocks like $2.4 billion E&P firm Clayton Williams Energy ( CWEI) have just as much effect on fund performance as the likes of XOM and CVX. But you’ll pay for that different weighting scheme; XOP charges 0.35 percent in fees, or well more than double the XLE.
Still, simple fund construction and low fees are an alluring combination that could make up for those overweights — especially given Exxon and Chevron’s total-return strength over time.
Fabian calls the XLE “one of the most efficient ways for investors to access a portfolio of energy stocks primed for a rebound.”
“Some of the advantages of using XLE versus an individual stock or mutual fund are its low cost, diversification, tremendous liquidity and tax efficiency,” he says. However, if XLE’s small basket of holdings is too narrow for your investment purposes, Fabian recommends the Vanguard Energy ETF ( VDE), “which has a broader base of 130 stocks to capture a wider array of energy market companies.
Kent Thune, president of Atlantic Capital Investments in Hilton Head Island, South Carolina, isn’t hedging his bets on energy or the XLE, which has beaten the VDE and XOP on a total-return basis over the past 10 years.
[See: 7 of the Best Stocks to Buy for 2017.]
“When structuring portfolios for clients, I like to recommend three or four sectors that I believe can beat the S&P 500 over the next three years,” he says. “Energy has been one of those sectors for me since early 2016, and XLE is my go to fund to fill that space.”
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XLE: This Energy ETF Is a King-Sized Winner originally appeared on usnews.com
