My 4% Dividend Yield Portfolio: Looking For The Best Energy Sector ETF

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Includes: IXC, VDE, XLE
by: Ron Honig

Summary

The Energy sector's performance has been lagging compared to the S&P500.

In the recent months the Oil price demonstrated weakness not being able to surpass the $50 bar.

In times of weak Oil price it is good time to consider a long term position in the Energy sector.

Here is my preferred U.S. Energy sector ETF.

It is a known fact that in the recent years the Energy sector has been lagging behind in performance compared to the overall equity markets. The steep drop of the oil price from the levels of $110 per barrel to the current range of $40-50 led to a significant turbulence across the entire sector and there was no company, even the most dominated ones, that did not had to make significant adjustments to its mode of operation in order to avoid a significant crisis.

The Oil price is a major factor that impacts the performance of the sector. The price is driven but multiple drivers and its behavior is highly volatile when exploring its price graph across the recent half-of-century.

The next graph compares the Energy sector to the S&P500 during the recent decade. Though the sector was underperforming during the last two years, there were relatively long periods of time where the Sector surpassed the performance of the S&P500.

One can argue that it was the high Oil price that allowed this advantage and indeed there is correlation between the Oil price to the sector's performance, but with that one should take into account the intrinsic changes that the sector went through to adjust to the new Oil price range. Whether it is focus on efficiencies, implementing new technologies or by cold decision making to focus on the profitable portions of the business while neglecting the rest would eventually lead the top notch companies in this sector to leap forward in times where the Oil price would move upwards again.

The energy sector is an interesting one for the long term investor that is interested in ongoing dividend flow because it is one of the most generous sector in term of dividend payout.

The next chart, taken from dividend.com, shows the dividend yield comparison between the different sectors. The Energy sector is a sub-sector among Basic Materials which is leading in yield.

Within the Basic Materials sector it is the Oil & Gas sub-sector that leads in dividend payout, while Oil & Gas refining and equipment have the highest yield.

As seen earlier in times when the Oil price is low, there are growing concerns about the sector future performance hence the sector get penalized in an aggressive manner.

If the Oil price will continue to be traded in the low $40's or even go down below that most likely there would be a significant reaction to the Energy stocks. As mentioned earlier, most of the companies have been spending the recent two years to get rid of all sorts of fat and adjust to a lower Oil price anyway. A pullback in the sector could be reviled as an opportunity in the long run.

For the long term investor that has the patience to sit on his hands, buy and wait for the efficiencies to kick in and for the financials to be improved I tried here to sort the Energy Sector ETFs in order to find the best one to use when opportunity comes along.

I started with a list of 28 Energy Sector ETFs taken from etfdb.com.

The entire list with each ETF profile can be found here.

I focused on 6 parameters: The ETF's dividend yield, the ETF's Management fees, the ETF's performance in the recent year, three years and five years and the number of holdings.

I graded the best ETFs under each category and here are the top three:

Vanguard Energy ETF (VDE) was found to be leading in all categories. The ETF has the lowest management fees at only 0.12% per year, it paid $3.86 dividend in the recent year which implies a 4% dividend yield.

The large amount of holdings allow the ETF to offer a broad and dip exposure to the U.S. energy sector.

iShares Global Energy ETF (IXC) was found to be a great ETF as well. The only downfall is the relatively high fees it charges.

Energy Select Sector SPDR ETF (XLE) was found to be third in line. It has a very competitive managerial fees and delivered a very similar return to the former two ETFs. The main difference is the amount of holdings that the ETF possesses. Its Top-10 holdings represent ~66% of the total ETF assets. This is very close to the ~63% of total ETF assets that VDE allocated to its Top-10 holdings. The implied conclusion is that the remaining 28 holdings represent ~34% of the ETF total assets while in VDE the remaining ~37% is spread across 127 different holdings. It means that the risk in XLE is higher.

Conclusions:

The single representative from the Energy sector within my 4% dividend yield portfolio is Chevron Corporation (CVX). The sector has been going through a tough process adjusting to the new low-price levels and I would look for an opportunity to add my exposure to it, while Oil price is below the $40-50 equilibrium.

If the Oil price would fall below $40 due to a temporary lower demand, macroeconomic concerns or any other reason I would consider adding a position in VDE to allow a wide exposure to the U.S. energy sector.

Disclosure: I am/we are long CVX.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The opinions of the author are not recommendations to either buy or sell any security. Please do your own research prior to making any investment decision.