S&P Bullish on Big Energy ETF

After a decent start to the year, some energy stocks and equity-based ETFs have come under pressure on news of the Federal Reserve's plans to perhaps taper its quantitative easing program as soon as later this year.

Already downtrodden large, state-run emerging markets oil companies have provided no shelter from the storm, but size is something to consider in the energy patch.

"One way to hedge against that uncertainty in the energy sector, or perhaps reduce the risk of that uncertainty, is with size," said S&P Capital IQ in a new research note. "Bigger energy companies that are in more places have less risk tied up in any one project, should it fail (e.g., drilling a dry hole). Bigger energy companies that play at both ends of the energy food chain are less exposed to dramatic rises or collapses in energy prices. Finally, bigger energy companies face less regulatory risk. If faced with higher royalties on oil and gas production in a frontier market, a bigger oil company can shift more of its focus to other markets."

Along those lines, S&P Capital IQ has five-star ratings on Dow components Exxon Mobil (NYSE:XOM) and Chevron (NYSE:CVX), the two largest U.S. oil companies. At the start of trading Monday, shares of Exxon were 4.8 percent year-to-date while Chevron was higher by 11.7 percent.

"Both have strong portfolios of upstream projects, and both have downstream operations that should benefit from historically high refining margins. To the extent that investors might be interested in the supermajors, but as part of a portfolio that includes other areas in the oil patch such as oil and gas equipment and services, an ETF might be worth reviewing," said S&P Capital IQ in the note.

Finding an ETF that features large weights to Exxon and Chevron is not difficult, but S&P notes its universe of Overweight-rated energy funds is just 12 compared to 40 total ETFs tracking the sector. Screening for ETFs that earn Overweight ratings in terms of cost and performance and that have over $1 billion in assets under management pares the list of choices down to three. One of those funds is the Vanguard Energy ETF (NYSE:VDE).

VDE is not the largest energy ETF by assets. That honor goes to the rival Energy Select Sector SPDR (NYSE:XLE), but VDE is cheaper than XLE with annual expense ratio of 0.14 percent. That fee makes VDE less expensive than 91 percent of comparable funds, according to Vanguard.

At the end of the first quarter, Exxon and Chevron combined for 35.6 percent of VDE's weight. Schlumberger (NYSE:SLB), the world's largest oilfield services provider, was the ETF's third-largest stock with a weight of 5.7 percent while ConocoPhillips (NYSE:COP) was the only other member of VDE's 169-stock lineup to receive an allocation of at least four percent. Other top-10 holdings include Occidental Petroleum (NYSE:OXY) and Anadarko Petroleum (NYSE:APC).

"VDE scores favorably on the S&P Capital IQ Quality Ranking, as well as for its Standard & Poor's Credit Rating (which is derived independently of S&P Capital IQ), although its Qualitative Risk Assessment is unfavorable, which we view as par for the course in Energy investing. The overall score on Risk-related parameters is Marketweight. Finally, as mentioned earlier, VDE scores an Overweight on its Cost parameters, led by its low expense ratio," said S&P.

Year-to-date VDE and XLE are both up about seven percent.

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