The energy sector has been the second quarter’s best performer. When it comes to exchange traded funds, traditional cap-weighted offerings, such as the Energy Select Sector SPDR (NYSEArca: XLE) and iShares U.S. Energy ETF (NYSEArc: IYE), have been prime beneficiaries of investors’ renewed affinity for energy stocks.
An often heard criticism of cap-weighted energy ETFs is large, arguably excessive exposure to Dow components Exxon Mobil (NYSE: XOM) and Chevron (NYSE: CVX), the two largest U.S. oil companies. Equal-weight ETFs like the Guggenheim S&P Equal Weight Energy ETF (NYSEArca: RYE) help investors dodge uncomfortable exposure to those stocks, which has not been a bad idea.
Year-to-date, XLE is up almost 13% despite an average gain of just 2.7% from Exxon and Chevron, confirmation that the energy sector’s upside, while in large part attributable to large-caps, cannot be tied to the sector’s two biggest companies. [Stick With Energy ETFs]
As an equal-weight ETF, RYE assigns weights ranging from 1.83% to 2.91% to its 44 holdings. Exxon and Chevron combine for just 2.4% of the ETF’s weight.
Much of the advantage of afforded by equal-weight ETFs over time is attributed to either higher weights to small-caps or a tilt toward value names. The latter is the case with energy ETFs. Take the example of the SPDR S&P Oil & Gas Exploration & Production ETF (NYSEArca: XOP).
Like RYE, XOP has scant exposure to Chevron and Exxon. XOP’s 83 holdings also have a weighted average market capitalization of almost $20 billion, firmly large-cap territory. Due the significant presence of large-caps throughout the energy sector, it is not a stretch to say the advantage of equal-weight strategies in the energy sector, such as those espoused by RYE and XOP, come by way of a value bias, not a small-cap premium. [Buy Energy ETFs Now]
RYE does, however, prove the old adage about there being no free lunch on Wall Street. The result of the ETF’s significantly reduced exposure to Chevron and Exxon is increased volatility. RYE’s standard deviation is 23.4%, according to Guggenheim data.
By comparison, IYE, which allocates offer a third of its combined weight to Exxon and Chevron, has a standard deviation of 18.9%.
RYE does have some other advantages, including a correlation to the United States Oil Fund (NYSEArca: USO) that is comparable to the correlations to USO displayed by IYE and XOP.
Investors have listened to the RYE story as $170.2 million of the ETF’s $240.6 million in assets under management have flowed into the fund just this year.
Guggenheim S&P Equal Weight Energy ETF