The gulf between energy stocks and the rest of the S&P 500 is only getting wider. And ETFs offer investors a way to narrow the gap in their portfolios.
The Energy Select Sector SPDR ETF is up more than 13.7% in the second half so far — miles ahead of all other sectors in that time. The S&P 500 itself is only up 0.7%. And the next-best S&P 500 sector since June is Communications Services Select Sector ETF. But it's only up 3.7%.
But unless you own energy-specific ETFs, you're likely missing the energy rally. The energy sector only accounts for 4.7% of the S&P 500, says Stacey Morris of Vetta Fi.
"It isn't substantial enough to meaningfully impact performance," she said. "Consider last year when energy did extremely well, but it did little to offset weakness from other sectors as the S&P 500 fell."
What's Driving S&P 500 Energy ETFs?
Skyrocketing oil prices are pushing energy ETFs higher.
The price of a barrel of light crude oil trading on the Nymex is trading at $88.16. It keeps hitting new highs all year, and is up nearly 40% from the 52-week low, says S&P Global Market Intelligence. Higher energy prices are a key driving factor of stubbornly high inflation. Some of energy's effects on prices are indirect.
"The primary driver of the miss on core (inflation) was driven by a swing in airline fares from down 8.1% last month to up 4.9%, which is simply an example of how energy prices bleed into core as 40% of airline costs are driven by energy prices," said Jay Hatfield, CEO at Infrastructure Capital Management.
Energy ETFs are an easy way for investors to add exposure to portfolios. "If investors want more exposure to oil prices, they will almost certainly need to look to energy-focused products," Vetta Fi's Morris said.
Digging Through Energy ETFs
The first energy stocks to consider are the ones focusing on oil and gas producers, Morris says.
Yes, it's possible to own ETFs that own oil itself. But Morris prefers the ETFs that own oil producers for a key reason. These companies "are broadly focused on free cash flow, and with that, companies are also focused on returning cash to shareholders through buybacks and dividends," she said.
That means ETFs of oil producing companies enjoy "tailwinds" of income and cash generation.
Among ETFs that focus on oil and gas producers, Morris likes the $4 billion-in-assets SPDR S&P Oil & Gas Exploration and Production ETF. XOP follows an equal-weighted index that includes oil and gas producers. She says it moves more closely with oil prices than a broad energy ETF like Vanguard Energy ETF or even the largest energy ETF, the $39 billion-in-assets Energy Select Sector SPDR.
Lots Of Options
Some other investors may opt instead for the more predictable areas of the S&P 500 energy sector. Master limited partnerships (MLPs), which typically own the pipelines that transport oil and gas, can be bought in ETF form.
The Alerian MLP ETF is the largest product in that category, Morris says. The ETF sports an SEC yield of 5.73%, much higher than the 1.76% yield on SPDR S&P Oil & Gas Exploration and Production.
But there's a tradeoff. "MLPs do not provide as much exposure to oil prices because of their fee-based business models," Morris said. Shares of Alerian MLP are up just 5.6% in the second half so far.
"If investors want energy exposure with more yield, then it makes sense to look to MLPs," Morris said.
S&P 500 Energy Is Driving Higher
| ETF | Symbol | % ch. since June 30 |
|---|---|---|
| Energy Select Sector SPDR Fund | 13.7% | |
| Communication Services Select Sector SPDR Fund | 3.7 | |
| Financial Select Sector SPDR Fund | 2.9 | |
| Consumer Discretionary Select Sector SPDR Fund | 1.9 | |
| SPDR S&P 500 | 0.7 | |
| Health Care Select Sector SPDR Fund | 0.1 | |
| Materials Select Sector SPDR Fund | -1.7 | |
| Technology Select Sector SPDR Fund | -1.7 | |
| Industrial Select Sector SPDR Fund | -2.6 | |
| Utilities Select Sector SPDR Fund | -1.8 | |
| Consumer Staples Select Sector SPDR Fund | -3.0 | |
| Real Estate Select Sector SPDR Fund | -3.8 |
