After enduring a bear market throughout 2022, investors once again find themselves at a crossroads when it comes to sector investing opportunities. Market sector valuations are diverging strongly, presenting a spectrum of potential investment opportunities that require careful consideration.
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According to financial data platform Finviz, U.S. market sector valuations are currently wildly varied, with energy sporting the lowest price-to-earnings, or P/E, ratio of just 5.9, starkly contrasted against the staggeringly high 37.2 P/E ratio within the technology sector as of July 16. For investors, the P/E ratio is a key measure of a company’s or sector’s value. A lower P/E ratio can suggest that a stock or sector is undervalued, whereas a higher ratio might suggest overvaluation.
This disparity, which appears to be driven by a vigorous run-up in tech stocks fueled by artificial intelligence, or AI, hype can create opportunities for discerning investors. While growth-oriented investors may opt to bet on the continued tech bull run and hope for more momentum, value investors may wish to focus on the comparatively downtrodden energy sector.
Alongside its inflation-fighting properties, the energy sector may also be poised for further growth, underpinned by several tailwinds. “Global oil and gas upstream capital spending has been relatively flat in recent years and there is an expectation that companies will be disciplined in spending,” says Nick Kalivas, head of factor and core equity product strategy at Invesco. “The disciplined capital spending and focus on shareholders has the potential to support oil prices and cash flow generation.”
Another catalyst is the pressing need for the U.S. government to replenish its Strategic Petroleum Reserve, or SPR. “As of July 7, 2023, the Department of Energy SPR inventory was about 347 million barrels,” Kalivas says. “It has not been this low since 1983 and was over 700 million barrels at its peak in 2011.” This impending demand could provide significant support for oil prices, thus boosting growth in the energy sector.
Even with these catalysts at play, picking the right energy stock ex-ante can be difficult, especially given the high volatility of the energy sector. “The price fluctuations in energy commodities impact the bottom line of those companies both positively and negatively,” says Peter Earle, economist at the American Institute for Economic Research. “Additionally, there is a high degree of regulation associated with energy firms, which can result in political risk.”
To mitigate these risks, investors can diversify via an exchange-traded fund, or ETF, that holds a basket of different energy sector stocks. “Diversification can blunt some of the effects of high volatility among certain constituents,” Earle says.
Curtis Congdon, president of XML Financial Group, agrees with Earle, noting: “The main benefits of owning an energy ETF are not having to guess which company will outperform, and reducing concentration risk by owning a broad basket of companies.”
Here’s a look at the seven best energy ETFs to buy in 2023:
| Energy ETF | Expense ratio |
| Vanguard Energy ETF (ticker: VDE) | 0.1% |
| Energy Select Sector SPDR Fund (XLE) | 0.1% |
| Invesco S&P 500 Equal Weight Energy ETF (RSPG) | 0.4% |
| VanEck Oil Services ETF (OIH) | 0.35% |
| iShares U.S. Oil & Gas Exploration & Production ETF (IEO) | 0.39% |
| Alerian MLP ETF (AMLP) | 0.85% |
| Invesco DB Energy Fund (DBE) | 0.75% |
Vanguard Energy ETF (VDE)
“Vanguard has a popular offering in VDE that provides low-cost, high-yield, diversified exposure to companies involved in the exploration and production of energy products including oil, natural gas and coal,” Congdon says. This ETF currently sports just over $6.9 billion in assets under management, or AUM, charges a 0.1% expense ratio, and pays a 30-day SEC yield of 3.3%.
By tracking the MSCI US Investable Market Energy 25/50 Index, VDE provides exposure to 114 U.S. energy sector stocks. As a market-cap weighted ETF, VDE is dominated by large-cap energy stocks, with top holdings including the likes of Exxon Mobil Corp. (XOM) and Chevron Corp. (CVX). Together, XOM and CVX currently account for 37% of the ETF by weight.
Energy Select Sector SPDR Fund (XLE)
“Generally, in energy we prefer ETFs that are market-capitalization weighted versus equal weighted,” says Adam Grossman, global equity chief investment officer at RiverFront Investment Group. “We prefer this because we believe larger companies will have better access to capital and are more likely to have diversified businesses at the margin.” An ETF that meets Grossman’s criteria is XLE.
As one of State Street’s suite of 11 “Select Sector” ETFs, XLE tracks the predominantly large and mid-cap energy stocks represented in the S&P 500. Currently, this ETF has a total of 23 holdings, with Exxon Mobil and Chevron again sitting in the No. 1 and 2 spots, respectively. Together, the two companies account for around 40% of the ETF’s weight. XLE charges a 0.1% expense ratio.
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Invesco S&P 500 Equal Weight Energy ETF (RSPG)
Investors looking to avoid the top-heavy nature of VDE and XLE may prefer RSPG, which equally weights the energy stocks of the S&P 500 index at a 0.4% expense ratio. “The broader and more diversified exposure to energy in RSPG reduces concentration risk and allows investors broader exposure to industry fundamentals and economics,” Kalivas says.
Kalivas also notes another potential benefit of RSPG’s equal-weight strategy. “The quarterly rebalancing process for RSPG causes the fund to trim exposure to stocks that are above their equal-weight percentage and add to stocks that have fallen below their equal-weight percentage,” he says. “Therefore, there is a buy-low, sell-high dynamic that is present.”
VanEck Oil Services ETF (OIH)
“Energy prices are cyclical, which leads to boom-and-bust behavior versus other industries that are more stable,” Grossman says. “This cyclicality makes lending in the space riskier from a credit standpoint, which makes financing projects more expensive.” In Grossman’s opinion, these dynamics play a large role when it comes to the relative undervaluation of energy sector stocks.
For a more targeted approach to a specific energy sub-sector, investors can buy OIH. This ETF tracks the MVIS U.S. Listed Oil Services 25 Index, which focuses on the upstream oil industry that consists of large-cap equipment, services and drilling companies. Top holdings include SLB (SLB), Halliburton Co. (HAL) and Baker Hughes Co. (BKR). OIH charges a 0.35% expense ratio.
iShares U.S. Oil & Gas Exploration & Production ETF (IEO)
“Geopolitical risks are very high for energy stocks, as supply chain disruptions or conflicts can massively impact pricing,” Grossman says. “Regulation of fossil fuels is aggressive globally, as there is a push to renewables and hostility when it comes to permitting energy-related activities.” Again, Grossman believes that these two factors have led to investors over-discounting energy stocks.
For investors seeking to focus on domestic energy stocks primarily involved in the exploration, production and distribution of oil and gas, iShares offers IEO. This ETF tracks the Dow Jones U.S. Select Oil Exploration & Production Index, which currently has 49 holdings. As a market-cap weighted ETF, the largest holding in IEO is currently ConocoPhillips (COP) at 18%. IEO charges a 0.39% expense ratio.
Alerian MLP ETF (AMLP)
AMLP holds master limited partnerships, or MLPs. These are unique publicly traded companies that possess the tax benefits of a partnership and pay out very high dividend yields. Case in point, AMLP currently pays a 30-day SEC yield of 6%. The MLPs represented in AMLP track the Alerian MLP Infrastructure Index, which focuses on the midstream segment of the U.S. energy sector.
AMLP holds midstream MLPs that process, store and transport oil and gas products. These MLPs serve as the vital link between the explorative upstream sector, where resources are extracted, and the downstream sector, where these resources are ultimately refined and sold. Thus, AMLP can complement an upstream-focused ETF like IEO. The ETF charges a 0.85% expense ratio.
Invesco DB Energy Fund (DBE)
For targeted exposure to energy commodities, investors can buy DBE. Unlike the previous ETFs, DBE does not hold energy sector stocks. Instead, the ETF utilizes derivatives called futures contracts, which provide exposure to the prices of different energy commodities. For investors unwilling or unable to trade energy futures on their own, DBE offers a professionally managed alternative.
By tracking the rules-based DBIQ Optimum Yield Energy Index Excess Return, DBE provides exposure to a portfolio of futures contracts tracking light sweet crude oil, heating oil, Brent crude oil, gasoline and natural gas. However, keep in mind that this ETF can be highly volatile due to fluctuating commodity prices. It is also fairly expensive with a 0.75% expense ratio.
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7 Best Energy ETFs to Buy Now originally appeared on usnews.com
Update 07/17/23: This story was previously published at an earlier date and has been updated with new information.
