When you look into the composition of the Pacer U.S. Cash Cows 100 ETF (ticker: COWZ), rated five stars by Morningstar, an interesting detail emerges: Its portfolio allocates a significant 21.5% to energy stocks.
This contrasts sharply with broad-market exchange-traded funds, or ETFs, like the iShares Russell 1000 ETF (IWB), which only allocates 3.4% to energy.
This discrepancy is linked to the differing methodologies of the two ETFs. The Russell 1000 Index, tracked by IWB, weights holdings by market capitalization, meaning the larger the company, the more weight it has, a setup that typically favors dominant tech companies.
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In contrast, COWZ, which has outperformed the Russell 1000 Index over the past five years with a 17.5% annualized total return versus 15.6%, employs a methodology designed to target companies with high free cash flow yield.
Free cash flow is essentially the money a company has left over after it pays for its operational expenses and takes care of its equipment and property. But on its own, this metric is incomplete.
To understand how well a company uses this money, investors look at the free cash flow yield, which is figured by dividing the free cash flow by the company’s enterprise value.
Enterprise value is often considered more accurate than just using market cap because it includes debt and subtracts cash on hand. This gives investors a fuller picture of what the company is really worth.
High free cash flow yield is a good sign because it indicates that a company is efficiently generating cash relative to its total value. With this available cash, a company can do several things: pay dividends to shareholders, buy back shares, reduce debt or reinvest in new projects to drive future growth.
This focus on free cash flow yield is what led to an overweight in energy stocks within COWZ. Many firms in the energy sector, accustomed to the boom-and-bust cycles of oil prices, have strengthened their balance sheets and, pun intended, now gush with free cash flow.
Moreover, on multiple valuation metrics, whether it be price-to-free-cash-flow, price-to-earnings, price-to-sales or price-to-book, energy sector stocks rank among the most undervalued in the U.S. market today.
Here are seven of the best energy ETFs to buy in 2024:
| ETF | Expense ratio |
| Energy Select Sector SPDR Fund (XLE) | 0.09% |
| Vanguard Energy ETF (VDE) | 0.10% |
| iShares Global Energy ETF (IXC) | 0.41% |
| Invesco Energy Exploration & Production ETF (PXE) | 0.60% |
| Invesco S&P 500 Equal Weight Energy ETF (RSPG) | 0.40% |
| Global X MLP & Energy Infrastructure ETF (MLPX) | 0.45% |
| Global X MLP ETF (MLPA) | 0.45% |
Energy Select Sector SPDR Fund (XLE)
“Energy ETFs offer investors a strategic tool to gain exposure to the sector’s growth potential while providing diversified exposure across energy sub-sectors, making them a great addition for portfolios looking to find some stability amidst geopolitical fluctuations,” says Joseph Spina, vice president at Northeast Private Wealth Management, an independent, New York-based private investment firm.
XLE is one of the most popular energy sector ETFs, with over $36 billion in assets under management. This ETF tracks the Energy Select Sector Index, which isolates the 22 large-cap energy stocks found in the S&P 500. It is market-cap weighted, with Exxon Mobil Corp. (XOM) and Chevron Corp. (CVX) accounting for 23.2% and 15.4% of its holdings, respectively. XLE charges a 0.09% expense ratio.
Vanguard Energy ETF (VDE)
“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,” says Curtis Congdon, president of XML Financial Group. “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.”
As with XLE, VDE offers market-cap-weighted exposure to the U.S. energy sector but doesn’t limit its selection universe to the S&P 500. By tracking the MSCI U.S. Investable Market Energy 25/50 Index, VDE is able to capture a more diversified portfolio of 110 holdings with slightly more emphasis on mid-cap and small-cap energy stocks. The ETF charges a 0.1% expense ratio.
iShares Global Energy ETF (IXC)
“We prefer energy ETFs that are market-capitalization weighted versus equal weighted,” says Adam Grossman, global equity chief investment officer and partner 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.” Another ETF to consider here is IXC.
Unlike XLE, IXC is globally diversified, tracking the S&P Global 1200 Energy 4.5/22.5/45 Capped Index. In addition to ExxonMobil and Chevron, IXC’s top holdings include the other “super-majors,” or Big Oil firms: Shell PLC (SHEL), BP PLC (BP) and TotalEnergies SE (TTE). It owns integrated, upstream, midstream and downstream energy companies from around the world. IXC charges a 0.41% expense ratio.
Invesco Energy Exploration & Production ETF (PXE)
“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 ETF strategy at Invesco. “The disciplined capital spending and focus on shareholders has the potential to support cash flow generation.” For exposure to upstream assets, consider PXE.
Unlike the previous ETFs, PXE doesn’t weight its holdings by market cap. Instead, upstream producers and explorers are selected based on price momentum, earnings momentum, quality, management action and value. Top holdings currently include Phillips 66 (PSX), EOG Resources Inc. (EOG), Marathon Petroleum Corp. (MPC) and Valero Energy Corp. (VLO). PXE charges a 0.6% expense ratio.
Invesco S&P 500 Equal Weight Energy ETF (RSPG)
With market capitalizations of $533 billion and $275 billion, respectively, ExxonMobil and Chevron dwarf the rest of the U.S. energy sector. As a result, market-cap-weighted ETFs like XLE and VDE are forced to allocate a proportionately higher weight to these stocks. The downside of this approach is concentration risk. Should either of these giants falter, it could drag the performance of these ETFs down significantly.
To mitigate this risk, consider an equal-weighted energy sector ETF like RSPG. “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,” Kalivas says. “Therefore, there is a buy-low, sell-high dynamic that is present.” RSPG charges a 0.4% expense ratio.
Global X MLP & Energy Infrastructure ETF (MLPX)
“Midstream companies handle the transportation of petrochemicals and natural gas and rely on long-term contracts with corporate clients in the energy industry,” says Kenny Zhu, research analyst at Global X ETFs. “This makes them less susceptible to short-term trends like energy prices and more reliant on transport and storage volumes.” To focus on midstream energy companies, consider MLPX.
This ETF owns a portfolio of both master limited partnerships (MLPs) and incorporated pipelines. The former includes names like Energy Transfer LP (ET), Enterprise Products Partners LP (EPD) and MPLX LP (MPLX). The latter includes the likes of Enbridge Inc. (ENB), TC Energy Corp. (TRP), Kinder Morgan Inc. (KMI) and Oneok Inc. (OKE). Investors can expect a decent 5.1% 30-day SEC yield from MLPX.
Global X MLP ETF (MLPA)
Prospective midstream investors should be aware of the potential tax consequences of directly owning MLPs. “MLPs pay high yields at consistent intervals thanks to their partnership structure, which allows these firms to avoid corporate-level income taxes,” Zhu notes. “However, the partnership structure of MLPs necessitates that buyers of MLPs must file Schedule K-1s with their annual tax returns.”
To avoid this entirely, investors can buy MLPA, which uses a registered investment companies-compliant structure, allowing it to be taxed as a pass-through entity. “MLPA handles Schedule K-1s at the fund level, negating the need for added tax filings, while offering exposure to the high yields generated by MLPs in a convenient and diversified investment vehicle,” Zhu explains.
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7 Best Energy ETFs to Buy Now originally appeared on usnews.com
Update 10/21/24: This story was previously published at an earlier date and has been updated with new information.
