Which ETF Is A Better Investment These Days, XLE Or VDE?

Summary

• The XLE is the gold standard.
• VDE is smaller and more flexible.
• Expense ratios favor VDE, liquidity favors XLE.
• Smaller caps could improve results.
• Both could be one step ahead of crude oil.

The crude oil price is hanging in there at over $60 per barrel on the nearby NYMEX crude oil futures contract. So far in 2018, the benchmark price has traded from a low of $58.07 per barrel on February 9 to a high of $66.66 on January 25. The low came on a day that the dollar was strong, and the high when the U.S. currency reached a low Meanwhile, even though the dollar made a lower low on February 16, crude oil did not rise to a new peak price. As the dollar has recovered since the middle of February, crude oil has remained over the $60 per barrel level.

Meanwhile, volatility in the stock market has caused the price of energy-related stocks to fall from highs on January 24. The benchmark XLE ETF had declined from a high of $78.39 on that day to a low of $64.45, and it has only managed to recover to the $67.66 level as of the close of business on March 5. Crude oil settled on that day at $62.57, 6.1% below its peak, while the XLE was 13.7% lower. Oil equities have underperformed the action in the crude oil market because of their beta with the overall stock market. Meanwhile, the smaller-cap Vanguard Energy ETF product declined even more than the XLE on a percentage basis from its high in late January to its mid-February low. Time will tell if the oil equities are telling us something about the price of the energy commodity, or if they are just suffering from the volatility in the stock market.

The XLE is the gold standard

When it comes to the ETF that most market participants watch for a read on the oil equity sector, the Energy Select SPDR or XLE is the gold standard. The XLE contains the biggest names in the energy industry that trade on stock exchanges. Exxon Mobil (XOM) and Chevron Corporation (CVX) account for 39.75% of the ETF. When you add Schlumberger (SLB), EOG Resources (EOG), ConocoPhillips (COP)., Occidental Petroleum (OXY), Halliburton (HAL), Phillips 66 (PSX), Valero Energy Corporation (VLO), and Kinder Morgan Inc. (KMI), the heavyweights in oil add up to over 65% of the index.

Source: Barchart

As the chart shows, even though the price of crude oil hit lows on June 21 at $42.05 and began its ascent to over the $60 per barrel level by the end of the year, the XLE continued to fall reaching its low at $61.80 on August 21. More recently, nearby NYMEX crude oil futures hit a high at $66.66 on January 25, and the XLE peaked on January 24 at $78.39 per share. Crude oil rallied by 58.5% from its low while the XLE posted a gain of 26.8%, less than half the move in the price of crude oil.

NYMEX crude oil was trading at $62.60 on Tuesday, March 6, after hitting bottom at $58.07 on February 9. The energy commodity declined by 12.9% from the highs at $66.66. Crude oil has since recovered by 7.8%. The XLE fell to a low of $64.45 on February 9, 17.8% below its peak on a combination of lower oil and overall weakness in the stock market and was trading at the $67.70 level on March 6. The XLE's recovery of 5.0% was lower than that of oil, and since late June, the XLE has underperformed the energy commodity.

The XLE is a highly liquid ETF with $19.46 billion in net assets, and it trades an average of over 15.3 million shares each day. Given the recent performance, the XLE is flashing a warning sign for the price of crude oil as its underperformance could be an omen that the path of least resistance for oil is shifting lower.

VDE is smaller and more flexible

The Vanguard Energy ETF (NYSEARCA:VDE) is similar to the XLE, but its size allows the product additional flexibility for those looking to invest in the oil sector. VDE holds the same cast of stocks as XLE, but the aggregate of the same top ten holdings adds up to a total of 64.41% which is only slightly lower than the XLE.

Source: Barchart

The chart shows the performance of the VDE since last June. Like the XLE, the VDE also reached its low on August 21 at $83.70 per share, and it peaked on January 24 at $107.20, an increase of 28.1%. The VDE posted better performance than the XLE over the period by 1.3%. The correction took the VDE to a low of $87.83 on February 9, 18.1% below the high. Over the period, the XLE declined by 17.8%, only 0.3% better than the VDE. On March 6 VDE was at $92.76 per share, just over 5.6% and above XLE's 5.0% appreciation over the period.

VDE has net assets of $4.97 billion, making it almost one-quarter the size of the XLE product, and it trades an average of just under 328,500 shares each day.

Expense ratios favor VDE, Liquidity favors XLE

The XLE charges an expense ratio of approximately 0.14% and has a turnover of holding of 23%. VDE's expense ratio is lower at 0.10% and its holding's turnover at the 11% level.

The XLE tends to attract bigger players in the oil equities market as it offers market participants over forty times the average daily trading volume. While the bid/offer spread on VDE tends to be around 4 cents, the XLE is typically half that level. Therefore, while expense ratios make the VDE a more attractive ETF product when it comes to cost to investors, liquidity favors the larger XLE.

Smaller caps could improve results

After an investigation of the disclosure documents for the two ETF products, it appears that VDE tends to make more investments in mid-size and smaller U.S. companies within the energy sector which is the likely reason for its performance differences with the XLE. From my perspective, as an individual investor, I would be more likely to invest in oil stocks for the medium to long-term using the VDE rather than the XLE index because of two reasons. First, the expense ratio is lower making it a cheaper product. Second, and more importantly, while past performance is no guaranty of future results, it appears that VDE has tracked the price of crude oil slightly better than XLE, at least since June 21 during a volatile time in the oil market.

Both could be one step ahead of crude oil

The one constant when examining the comparative performance of both the XLE and VDE products is that they have been lagging the price action in the crude oil market over recent weeks. The correction in the stock market weighed heavily on equity prices and the beta with the stock market is responsible for the weakness in the energy equity sector.

However, on a longer-term basis, crude oil rallied from $26.05 per barrel in February 2016 to its most recent high of $66.66, a rise of 156%. During that period, XLE underperformed oil, rising from lows of 57% while the VDE appreciated by 56.2%. Many of the companies held in these two ETF products have vast interests in U.S. production. With rig counts rising, U.S. production at 10.2 million barrels each day and rising, technological advances in extraction, fewer regulations, and tax reform production costs have moved lower. If the price of crude oil remains above $50 per barrel, it is likely that earnings of the oil companies will support the value of these ETF products. Moreover, if the Aramco IPO lifts the valuation of companies in the oil sector later this year or early next year, we could see an adjustment in these two products.

I favor VDE as a small investor, but for hedge funds and other pools of capital moving massive capital around the market, the XLE is likely to remain the gold standard when it comes to reflecting the performance of the oil equity sector.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.