Energy ETFs are Limited by International Exposure
Joshua is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Adding international exposure to a portfolio is commonly cited as a way to reduce risk and volatility. In the modern interconnected economy international exposure can easily expose investors to hidden risks. Given the localized nature of some markets a given investment thesis may be relevant for the U.S. market, but not for the international market. Rising natural gas and coal prices in America will be very beneficial for U.S. energy companies but given the localized nature of natural gas markets, Asian energy firms will not see the same benefit. In the broader oil and gas sector international exposure offers a more positive risk reward situation.
Coal
U.S. coal prices are starting to increase in line with U.S. natural gas prices and coal ETFs can offer a deceptively simple way to gain access to the market. Market Vectors Coal ETF (NYSEMKT: KOL) has significant portions for its portfolio in Chinese and Asian coal companies which face distinctive dynamics from the U.S. market. China Shenhua and China Coal are traded in Hong Kong and form about 13% of holdings. Yanzhou Coal Mining is another significant Asian coal miner at 4.7% of holdings. Peabody Energy is a U.S. company but they recently bought assets in Australia to take part in the Asian market. Together these companies form more than 20% of the holdings and give the ETF serious exposure to Asia and China. Non-OECD energy needs are expected to grow over the coming decades but those looking to take advantage of the short term rise of U.S. natural gas and coal may find KOL rather lacking.
The Broad Energy Sector
Energy Select Sector SPDR (NYSEMKT: XLE) is a massive ETF with over $7 billion in assets under management. This ETF is very concentrated as the top 5 holdings of ExxonMobil, Chevron, Schlumberger, Occidental Petroleum, and Conocophillips form around 49% of total holdings. Here international exposure helps provide diversity for the ETF as non-OCED sources provide a large amount of the growth in oil supplies. The fund has varied exposure to downstream and upstream assets through the majors like ExxonMobil. This diversification helps to give a more holistic view of the sector. The Expense ratio is a healthy .18%.
IShares Dow Jones US Energy Sector (NYSEMKT: IYE) is a similar broad based energy ETF with a very similar make up. The top 5 holdings of ExxonMobil, Chevron, Schlumberger, Conocophilips, and Occidental Petroleum make up 55% of holdings. Similar to XLE, IYE offers international exposure through the oil majors. The expense ratio of .47% is double that of XLE. Reducing fees is a critical part of increasing long term returns. The difference in expense ratios helps to explain why IYE has only $1.1 billion under management. Given the similar holdings of these two ETFs XLE offers lower costs and thus is more likely to offer superior returns over the long run.
Exploration and Production
SPDR S&P Oil & Gas Explore & Prod. (NYSEMKT: XOP) is a very diversified fund with each of the top 10 holdings making up around 1.7% to 1.6% of total assets. A some of the holdings like Marathon Petroleum and ExxonMobil have significant refining operations and show that the ETF is not strictly exploration based. These refining assets help to make the fund less risky than those composed of highly leveraged juniors or cash crunched natural gas producers. The expense ratio of .35% is not the lowest in the industry but the average 1 year forward P/E ratio of 14 is not outrageous. As in the energy sector energy sector international exposure is built into the fund through the assets of the individual companies. For those looking for a highly diversified Energy ETF this ETF is a solid option.
Oil Equipment and Services
iShares Dow Jones US Oil Equip. (NYSEMKT: IEZ) has a relativity high expense ratio of .47% and is rather concentrated with the top ten holdings representing around 67% of holdings. Through their holdings in innovating drillers, like Baker Hughes, the fund offers exposure to shale gas and other growing areas of the energy sector. As in the other funds the majority of international exposure is given by the assets of the individual companies. Given the world's increasing energy needs and need to develop non-traditional petroleum resources like shale gas and ultra-deepwater these driller companies are set to see strong demand for their services over the long run. Given the relatively high expense ratio long term investors looking for a simple energy sector may find it best to look at XLE instead.
Conclusion
ETFs offer an easy way to get exposure to the energy market but those focusing on investments in the U.S. market may be disappointed. Many of the funds use large oil majors like ExxonMobil to generate a large percentage of these holdings. These majors have a large variety of exploration, production, and refining assets scattered throughout the world. In the long run this intentional exposure is a blessing as it offer stability and opportunity. In the short term the correction of the U.S. natural gas glut and the boost it will give to the U.S. energy sector can be better played through specific companies.
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