On this episode of ETF Prime, VettaFi’s Stacey Morris offered a quarterly update on the energy sector and energy ETFs with host Nate Geraci. Candriam’s Alexandra Russo later joined Geraci to discuss ESG investing mishaps and opportunities.
Energy Sector Underperformance YTD
Geraci kicked off the discussion with Stacey Morris, head of energy research at VettaFi, highlighting energy sector underperformance this year. Oil prices, which held at a steady range between $75-$80 a barrel between November 2022 and March 2023, dropped mid-March.
“In mid-March, you had the banking crisis really come to the forefront,” Morris said. “That set off significant fears about the economy, a recession, and just led to risk-off sentiment in the market.”
The pivot to risk-off created pressure on energy stocks and oil prices and resulted in broad energy moving similarly to banks. This comparable underperformance makes sense because of the similar nature of banks and the energy sector.
Both are cyclical stocks, Morris explained, and value-oriented, with economic sensitivity. Add into that the more direct correlation that a banking crisis would likely prompt a faster recession, driving down oil demand, and the tandem movement makes more sense.
That said, the most recent earnings season was a relatively positive one for the energy sector. Producers continue to capitalize financially on commodity prices, but the macro environment weighs heavily on energy.
Drilling Into MLP Performance Within the Energy Sector
Midstream performance remains relatively resilient this year. For comparison, oil field services, and funds like the VanEck Oil Services ETF (OIH), declined sharply in March.
“Much like oil and gas producers, oil field service companies can be sensitive to what happens with commodities,” explained Morris. “Fast forward a bit to this month on Q1 earnings calls, you had producers talking about how well costs are starting to plateau.”
Morris noted that midstream and MLPS are the only areas within energy this year to exhibit “notable gains.”
The Alerian MLP Infrastructure Index, the underlying index for the Alerian MLP ETF (AMLP), is up 7% on a total-return basis YTD. Yields for the index were also noteworthy at 8% as of 05/26/2023. A fee-based structure allows for steadier cash flow for many MLP companies, and MLP EBITDA growth helped buoy the space compared to broader energy.
Midstream also experienced further lift from the ONEOK acquisition of Magellan Midstream Partners. Magellan is a security carried in most MLP indexes and funds and the acquisition included a 22% premium, Morris explained.
Advisors and investors looking to invest in MLPs won’t find them within the S&P 500 however. Because they issue K-1s for taxes, they are generally excluded from broad indexes. MLP exposure instead comes from specific energy-centric indexes and funds, like AMLP.
MLPs offer several benefits to portfolios that make them worth consideration. These include diversification, defensive positioning, dividends, and tax advantages.
“They’re pass-through entities, they pay generous dividends, and a portion of those dividends are typically tax-deferred,” Morris said. “Most people come to the MLP space for that tax-advantaged income.”
Morris went on to discuss the energy sector outlook in the coming months and the move towards renewable energy sources.
The Evolution of ESG Investing
Alexandra Russo, head of U.S. ESG client portfolio management with Candriam, appeared next to talk ESG investing. Candriam is a pioneer in sustainable investing and offers funds like the IQ Candriam ESG U.S. Large Cap Equity ETF (IQSU). For a global approach, Candriam offers the IQ Candriam ESG International Equity ETF (IQSI).
“Today we have about 25 resources dedicated to ESG in-house,” Russo explained. “This has allowed us to develop a proprietary ESG scoring model which helps us better understand how companies are managing their ESG risks and opportunities.”
The challenges ESG has faced in recent years, particularly within the U.S., come from the broad nature of ESG itself. While it encompasses a wide variety of strategies and diversified investment goals, opponents of ESG tend to lump all approaches together. This translates into people assuming that all ESG investing involves divestment or exclusionary approaches, or other broad assumptions.
ESG as a term has become synonymous with confusion, and politics, and Russo believes how it is labeled will evolve. That said, “We need to be more transparent about what we’re using ESG data to achieve,” said Russo. In doing so, new labels that more accurately reflect individual strategies would bring clarity and help to build confidence in the space.
Candriam’s approach is to utilize ESG data to identify risk factors for companies and opportunities first and foremost. Climate benefits are a secondary benefit that can be targeted more specifically for individual clients that may prioritize that, but it isn’t the baseline.
Candriam analyzes thousands of ESG KPIs to understand individual industries and how a company stacks up. This analysis also enables better clarity regarding fundamental risks and forward-looking opportunities.
“More and more over time we are seeing fundamental investors consider ESG data alongside traditional data,” Russo explained. “I think that the overall institutional investor community does believe that ESG factors matter.”
The conversation covered how ESG data is used and how markets filter ESG information. Also discussed were the strategies the Candriam ETFs use and what sets them apart.
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