Oil fell to four-month lows last week, a reminder that energy investing comes with risk, not just reward.
“OPEC+ production cuts were extended as expected, but incremental voluntary cuts from select countries are set to start unwinding in October,” explained Stacey Morris, head of energy research at VettaFi. “Even though the increase in production is subject to market conditions, the initial reaction was a concern that the unwind may be coming too soon. Demand may not be strong enough to absorb the incremental barrels.”
High-Quality Energy Companies
The good news is some energy-oriented equity ETFs focus on high-quality companies that are more than a play on oil prices. Strong free cash flow (FCF) generation and returning cash to investors has been a key theme for the broad energy sector in recent years.
Energy infrastructure MLPs stand out for more stable FCF generation that is not dependent on oil or natural gas prices, according to Morris. For these MLPs, FCF is a product of fee-based business models and capital discipline with growth projects. The excess cash has facilitated debt reduction and generous returns to shareholders through boosting dividends and repurchasing stock.
The Alerian MLP ETF (AMLP ) is the largest MLP-focused ETF, with $8.3 billion in AUM. Holdings include Energy Transfer, MPLX, and Plains All American Pipeline. Each has double-digit free cash flow yields. Next week, I’ll be hosting a webcast with Morris to discuss how FCF tailwinds are helping MLPs weather commodity price volatility. The Global X MLP ETF (MLPA ) is another sizable ETF focused on MLPs.
Energy Is a Hefty Stake in Cash Flow ETFs
Given the broad focus on free cash flow, energy is the largest sector in some of the more broadly diversified FCF-focused ETFs. The Pacer Cash Cows ETF (COWZ ) recently had 23% of assets in energy companies. Meanwhile, the VictoryShares Free Cash Flow ETF (VFLO ) had 25% of assets in the sector.
Chevron and Exxon Mobil were top-10 holdings in both ETFs. However, while COWZ had a relatively high stake in materials (10%), VFLO had more in information technology (16%). The differences stem from the index construction process. VFLO takes a more forward-looking approach.
Drilling Into Dividend ETFs
The strong FCF has helped energy pay sizable dividends over the years. This has also helped dampen volatility. The iShares Core High Dividend ETF (HDV ) has 24% of assets in energy companies. That was again led by Exxon Mobil and Chevron. Meanwhile, the Invesco S&P 500 High Dividend Low Volatility ETF (SPHD ) had an 11% stake that included Kinder Morgan and ONEOK.
Both ETFs offer more energy exposure than the 4% the S&P 500 Index. But some advisors might want even more. The Amplify Natural Resources Dividend ETF (NDIV ) has 75% of assets in energy companies, including MLPs Energy Transfer and MPLX. The remainder of the fund is focused on chemicals and metal & mining companies.
VettaFi is the index provider for AMLP, NDIV, and VFLO, for which it receives an index licensing fee. However, AMLP, NDIV, and VFLO are not issued, sponsored, endorsed, or sold by VettaFi, and VettaFi has no obligation or liability in connection with the issuance, administration, marketing, or trading of AMLP, NDIV, and VFLO.
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