Energy ETFs: Equal Weight Or Market Cap?

Includes: RYE, XLE
by: Tom Lydon

Oil prices fell back below $100 a barrel in Thursday’s risk-off market action, dragging down exchange traded funds that invest in energy stocks.

These sector ETFs have benefited from the recent spike in oil prices, but performance among the funds can vary due to differences in the various tracking indexes.

In a research note, Isabelle Sender, S&P Capital IQ editor, compares two large-cap energy sector ETFs: the market-cap weighted SPDR Energy Select Sector Fund (NYSEARCA:XLE) and the equal-weighted Rydex S&P Equal Weight Energy ETF (NYSEARCA:RYE).

“Underlying holdings’ weightings should be considered when deciding among energy ETFs,” Sender said.

The equal-weighted methodology allows small-cap holdings to exert greater influence on the overall movement of the fund while diminishing the influence of large-cap stocks. The market-cap weighted methodology allows the big and established firms to exert more influence the overall direction of a fund. [

The majority of S&P’s analysts’ favorable rankings are for companies with $5 billion or more in market-cap. S&P Capital IQ Equity Analyst Stewart Glickman notes that large-cap energy stocks provide income generation, which makes up a large percentage of total return over the long-term, and relatively low volatility.

The equal-weight RYE has a 12-month yield of 0.58% while the market-cap weighted XLE has a 12-month yield of 1.55%, according to Morningstar.

“It’s not surprising that XLE has a lower standard deviation because it has more exposure to higher quality names that are less buffeted by oil and gas price volatility,” Glickman added.

Large oil & gas companies “are high-quality names, and those names have outperformed in down markets, such as in 2008 when the broader S&P 500 was down 37% on a total-return basis.” During that time, “integrated energy companies were only down about 22%, partly on a flight-to-quality theme,” Glickman said.

SPDR Energy Select Sector Fund

(Click to enlarge)
Max Chen contributed to this article.