Buy the market. You’ll do just fine.
That advice has treated many Main Street investors more than fine over the years. And many have questioned just how much better off they would have been if they took that advice to heart. Financial journalists dubious of Donald Trump’s business prowess, for example, ran stories that Trump would’ve been nearly as well off had he simply bought the S&P 500.
That’s because, of the many benchmark indices, the S&P is the most faithful representation of the overall stock market. And, yes, if you buy and hold the market over the long term, you will likely be fine. But for investors who are already long certain sectors and who want to diversify, or for those looking to make more tactical decisions, there are ex-sector funds like ProShares S&P 500 Ex-Energy ETF (NYSEARCA:SPXE).
Introduced in 2015, ProShares’ ex-sector exchange-traded funds are “based on a simple idea,” says Simeon Hyman, ProShares’ Global Investment Strategist. I asked Hyman if SPXE ETF investors are passive or active, to which he says, “ex-sector ETFs may be appealing to a wide-range of investors — from active traders who have a negative near-term view on a sector, to passive ‘buy-and-hold’ investors who want to tailor their core stock portfolio and avoid a sector they believe may underperform long-term.”
While index (or ETF) investing is traditionally thought of as passive investing, ETF investors rarely act passively from a behavioral perspective. In some respects, ProShares’ basket of ex-sector ETFs feels like a thoughtful reaction to a rise in active trading through passive investment vehicles. In fact, this is partly why SPXE is appealing, as it eschews the idea of replicating the market’s performance in favor of staying one step ahead.
Why Invest in Ex-Sector ETFs?
“Instead of buying individual stocks, many investors may have a broader view on where to find opportunity, and sector ETFs are an efficient way for people to express those views,” says Hyman. “It’s not uncommon for an investor to inadvertently be overexposed to a sector or have sectors in their portfolio they just don’t want.”
But if you’re not investing in an index-tracking ETF to buy the market warts and all, then what’s the point? According to Hyman, “SPXE may potentially help investors with several different objectives.” For one, Hyman says investors simply may want to avoid sector-based volatility. “Some people may note energy’s recent volatility and under-performance and decide to avoid the sector for now,” he says.
Others, Hyman notes, “may work in the energy business and want to diversify their core equity holdings from their income or stock options, and use SPXE for that purpose.” On the opposite end of that spectrum are “climate-conscious investors,” who avoid traditional energy firms “because owning fossil fuel companies doesn’t align with their values.”
But SPXE isn’t just for investors who are already knee-deep in energy stocks or those who avoid energy outright. There are also forward-looking investors who see the impact of environmental, social and governance (ESG) principles on capital markets.
“Fundamental investors may notice that today’s energy sector is dominated by oil and gas companies they believe may not be shifting quickly enough to renewables.” These folks, Hyman notes, find it beneficial to own the S&P without the sector that’s slowly going underwater.
SPXE: A ‘Hidden’ ESG Investment
Oil producers have been severely impacted due to the double whammy of coronavirus lockdowns and a failed OPEC deal. Gas producers, however, have been more resilient. This has led many investors to rummage through the energy stock wreckage for value plays — especially in diversified, integrated energy firms.
But the energy sector has problems beyond the scope of 2020. There’s a systemic change underfoot, with policies born out of the Green New Deal threatening the viability of the fossil fuel industry over the long term. So far this year, the Energy Select Sector SPDR (NYSEARCA:XLE) has dropped 38.6%, leaving dividend-chasers and value hunters in a lurch. In fact, many others are holding ticking time bombs in their portfolios without even realizing it.
“People concerned about the energy sector may not realize that they’re adding to their energy exposure when they make contributions to S&P 500 funds or other core stock funds,” Hyman elaborates. “While it’s simple to add a sector to a portfolio, prior to the introduction of the ex-sectors there wasn’t really an easy way remove a sector from the S&P 500 — an investor would have to build a portfolio out of many individual ETFs, determine their weightings, and rebalance regularly. The ex-sectors ETFs were designed to help simplify the process of customizing your core stock portfolio. SPXE, for example, enables an investor to own the S&P 500 with the energy sector removed.”
Considering that the SPXE is up 5.12% this year versus the S&P’s 3.15% gain, the strategy appears to hold water. The notion of ESG investing, once merely cosmetic, is now a major factor for investors to consider. Legal & General’s Climate Impact Pledge, for example, pushes businesses to be on the right side of climate change. And funds that invest according to ESG principles have experienced record-breaking inflows since the coronavirus pandemic.
“The long-term trend for fossil fuels is one of decline, and gas companies are not immune to those headwinds,” Hyman notes. “According to the U.S. Energy Information Administration, natural gas is expected to be surpassed by renewable energy as the primary source of electric power in the U.S. as soon as 2045.”
What does the SPXE do with all of the extra bandwidth left from energy stocks? “The portfolio begins with the S&P 500 and removes a sector, redistributing its weight among the 10 remaining sectors,” Hyman says. Basically, the SPXE gives investors slightly more exposure to the parts of the market driving growth. Here’s a chart of SPXE’s holdings compared to the S&P 500 Index:
With energy completely scrapped, the ETF allows more weighting for sectors that are driving growth in renewable energy:
“A key feature of SPXE is that investors get the S&P 500 — perhaps the most iconic representation of leading companies in the U.S. — but without the energy sector. This is an important point precisely because the U.S. companies driving the transition to renewable energy today may not be companies in the energy sector currently. Instead, the companies at the forefront of the move to renewable sources today are Utilities, Technology, Materials and Consumer companies — sectors that are a part of SPXE’s portfolio. [This includes] companies like NextEra Energy (NYSE:NEE) — a leading renewable power producer; Microchip Technologies, Inc. (NASDAQ:MCHP) — a supplier of critical components for solar cells; Albemarle Corporation (NYSE:ALB) — producer of lithium for use in batteries; and BorgWarner Inc. (NYSE:BWA) — one of the largest producers of powertrain parts for electric vehicles, to name just a few.”
Bottom Line on the SPXE ETF
Hyman’s right to point out the growth in renewable energy sources. In the U.S., renewable energy sources are set to make up 21% of the country’s electricity use, which is more than double the 10% it made up in 2010. Importantly, a lot of that growth is coming in spite of the draw down in traditional energy.
Where previously, declining crude oil prices led to increased energy uses, the post-coronavirus world has seen a stronger push toward renewables. Investors who believe in the bull case for renewables may find that SPXE allows them to own the market in a forward-looking way.
One point of contention, however, is the SPXE’s expense ratio of 0.27%. That’s something for investors to consider, as the management fees are much higher than one would pay for an S&P-tracking product like the SPDR S&P 500 ETF Trust (NYSEARCA:SPY), which currently sits at 0.095%.
But for investors looking to de-couple from a highly combustible energy sector, the extra fees may be worth it.
And the SPXE ETF is just the tip of ProShares’ ex-sectors iceberg. In addition to its ex-energy ETF, ProShares introduced an entire suite of ex-sector funds, including:
- S&P 500 Ex-Financials ETF (NYSEARCA:SPXN)
- S&P 500 Ex-Health Care ETF (NYSEARCA:SPXV)
- S&P Ex-Technology ETF (NYSEARCA:SPXT)
Like SPXE, these ex-sectors funds offer something for every investor who’s looking to diversify their exposure or de-risk their portfolios.
John Kilhefner is the managing editor of InvestorPlace.com. As of this writing, he did not hold a position in any of the aforementioned securities.