Listening To What Energy ETFs Have To Say

The energy sector and its exchange traded funds are still struggling this year. That much is confirmed by some of the big-name ETFs tracking energy stocks. For example, the Energy Select Sector SPDR XLE, the largest energy ETF, is down more than 5 percent year-to-date. The SPDR S&P Oil & Gas Exploration & Production ETF XOP is off 18.2 percent this year.

Those declines come after XLE and XOP lost 21.5 percent and 35.8 percent, respectively, last year. Clearly, the environment is difficult for the energy sector, but that is not keeping investors. In fact, energy ETFs are prolific asset gatherers. That could be a sign paying attention to flows to the sector's ETFs could pay off in the future.

“Since oil prices topped out in 2014, US-listed energy ETFs such as Energy Select Sector SPDR Fund [XLE] have gathered $4.7 billion. That is the most of any equity sector. These inflows appear to be driven by investors taking long positions in energy ETFs to position for a recovery in oil prices. Of course, this trade hasn’t worked out so far with XLE down 19% since the peak price of oil on June 24, 2014,” said State Street Vice President David Mazza in a recent note.

Energy ETFs also face dividend issues, and those issues are not pleasant. Last year, when the energy sector was the worst performing group in the S&P 500, energy stocks accounted for the bulk of the negative dividend actions in the benchmark U.S. equity index.

Negative dividend action is one issue plaguing XLE and rival energy ETFs. Low oil prices and reduced capital spending by oil companies, exclusive of dividends, are others. Still, investors willing to wager that the worst has passed the energy sector might want to consider making that bet with XLE, but that bet won't be bump-free.

Again, investors are not being shy about embracing energy ETFs. Year-to-date, XLE has added nearly $801 million in new asset while inflows to XOP are just over $171 million.

“It’s natural to wonder if this activity in energy ETFs is being driven by rising short interest from traders betting against the energy sector. However, this isn’t the case. Even as energy has underperformed every other sector, investors have put money to work on the long side after covering their short positions. As we filter the signal from the noise, it looks like investors initially timed their bearish positions on oil very well, but have been early betting on a rebound. When it comes to investing, early and wrong are the same thing,” adds Mazza.