Energy ETFs Suffer As Oil Price Falls

Energy ETFs Suffer As Oil Price Falls

With the price of oil down sharply from its mid-summer highs, some investors who put money into energy-sector exchange traded funds have slipped up as well.

Despite a small bump late last week, the price of crude oil has fallen about 22 percent from its July peak of close to $80 a barrel and pulled stocks of major energy companies down along with it.

ETFs in the sector haven’t bucked the trend. The largest energy-oriented ETF, Energy Select Sector SPDR Fund, with about $4.6 billion in assets, has dropped 9 percent from mid-July. Top holdings are ExxonMobil Corp., Chevron Corp. and ConocoPhillips.

For investors, the quick combustion of oil-related ETFs is a reminder of the volatility inherent in betting on narrow slices of the stock market.

ETFs resemble index-oriented mutual funds but trade on an exchange like a stock. Many ETFs replicate broad well-known stock market indexes, like the Standard & Poor’s 500. However, as the funds have grown in popularity, their strategies have become more elaborate and exotic, following stocks in all corners of the market.

Advisors caution against Main Street investors using ETFs to pile into hot sectors, rather than cautiously spreading their money over all kinds of investments.

“I wouldn’t be averse to investing 5 percent in the energy sector, and 5 percent to 6 percent in (oil thirsty) emerging markets,” but no more, says Russell Wild, an Allentown, Pa., investment adviser. Swings in narrow slices of the market can be “gut wrenching,” he says.

A silver lining: Since energy-related ETFs hew to their index of choice, they would be a good bet for investors who think a recovery in oil prices is in the cards. Unlike actively traded mutual funds, energy-related ETFs don’t boost holdings of cash or take other measures that would buffer their fall — or limit their gains should oil prices turn around.

For those that do have the stomach to place bets on the direction of energy markets, now may be just the time to get in the game.

“I think this decline is providing a lower-risk entry point to for someone to establish a position in a market that has long-term fundamentals,” says J.D. Steinhilber, founder of investment service AgileInvesting.

Steinhilber recently added a 3 percent position in the Energy Select Sector SPDR to the model portfolio he sends clients.

“I’m still a big believer in the long-term bull market in commodities,” he says.

At least 10 different ETFs now track energy stocks, according to a recent quarterly report by Morgan Stanley. There is also one ETF that tracks the price of oil itself.

During the recent slip in oil price plain energy stock funds haven’t been the worst performers. ETFs that focus on service companies have declined even more sharply.

The iShares Dow Jones US Oil Equipment and Services Index Fund is down 22 percent since the fund began trading in May. The fund’s top holdings, companies like Schlumberger Ltd., Halliburton Co. and Baker Hughes Inc., tend to have more natural gas exposure than large oil companies, according to Friedman, Billings, Ramsay & Co. analyst Robert Mackenzie.

“Natural gas has fallen even more than oil,” Mackenzie says. “Prices are near the point where natural gas companies could cut drilling,” which would eat into the supply firms’ earnings.

In addition, the U.S. Oil Fund, which gives investors direct exposure to the price of oil by investing in futures contracts, has also declined more steeply than energy-company equity funds, which have been buffered by the strong stock market. The oil fund is down 20 percent since it began trading in April.

That fund’s decline doesn’t mean that it’s necessarily safer to invest in commodity-related stocks than commodities themselves. The dynamic can work the other way, too.

“In ’87, when the market crashed, people thought they were safe in gold stocks,” says Dave Fry, founder and publisher of ETF Digest, an investment newsletter. “Those stocks (still) fell apart, and people lost lots of money.”

The falling energy prices have been accompanied by big outflows in energy ETFs. However, the outflows don’t necessarily indicate investors are cutting exposure to energy stocks.

Because ETFs can be sold short or used to hedge complicated bets on the market, analysts frequently caution that ETF asset flows give a clearer picture of institutional trading activity than investors’ attitudes.

In fact, while energy ETFs have lost assets recently, the outflows began in July, when oil was at its peak.

Energy sector ETFs saw net outflows of about $234 million in July, $300 million in August, and $507 million in September, according to AMG Data Services.

“What happened is not a reflection on sentiment in the market,” says Robert Adler, President of AMG. “It’s institutional activity.”

Share this post