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Energy Equity ETFs: Disappointing Inflation Hedges


According to the latest data, U.S. inflation is tame. In late September, the Commerce Department said consumer price inflation fell 0.1%. When excluding the volatile food and energy categories, prices only rose at a 0.6%, the weakest core reading since early 2009.

There are no guarantees that benign inflation in the world’s largest economy will be a permanent fixture and if inflation, some investors are likely to turn to energy stocks and ETFs as inflation hedges. They may be disappointed by the performance of ETFs like the Energy Select Sector SPDR (XLE) and the Vanguard Energy ETF (VDE) in high inflation environments. [Big Energy ETFs Show Vulnerability]

Attain Capital Management recently compared the performance of XLE, the largest energy ETF by assets, against the BarclayHedge CTA Index, an index of managed futures, during the January 2007 – June 2008 period. That was a high inflation period as crude futures spiked to $133 from $61 per barrel, as Attain Capital noted.

Attain compared the managed futures index against XLE”by multiplying the monthly profits and losses of the BarclayHedge CTA Index by 3.25,” noting that in January 2007-June 2008 time frame, the managed futures strategy outperformed the ETF by over 1,600 basis points with a drawdown of 9.76% compared to almost 12.3% for XLE. The firm went on to note that since XLE debuted in 1999, it has slightly lagged the CTA Index with a drawdown more than twice that of the managed futures play.

XLE showed a correlation of 0.63 to the S&P 500 over that time compared to -0.15 for the CTA Index, according to data provided by Attain.

On the other hand, there is no denying that XLE and VDE are cheap and their three-year performances are solid. XLE charges 0.18% per year and VDE is even cheaper at 0.14%. The two ETFs generated average returns of 55% over the past 36 months compared to just 4.8% for the U.S. Oil Fund (USO).

This year, however, XLE and VDE have both lagged the S&P 500 despite higher oil prices and soaring U.S. oil output. XLE and VDE lagging the broader market can be in part attributed to the ETFs’ excessive weights to Dow components Exxon Mobil (XOM) and Chevron (CVX). For example, XLE allocates a combined 29.6% of its weight to the two largest U.S. oil companies. Despite the heft of Exxon and Chevron, the two have lagged the broader market this year. Exxon Mobil has actually lost 2.7%. [Shale Revolution Boosts Obscure Energy ETF]

Energy Select Sector SPDR

ETF Trends editorial team contributed to this post.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.