GOOGL - DIG ETF: Caution Due To Economic Risks

2023-10-25 15:02:21 ET

Summary

• ProShares Ultra Oil & Gas ETF is a leveraged fund that aims to provide twice the daily performance of the Dow Jones U.S. Oil & Gas Index.
• DIG has significant holdings in Exxon Mobil and Chevron, with over 30% of its assets allocated to these energy giants.
• The ETF underperformed the broader market in 2023, but short-term investors speculating on a surge in oil prices may find an opportunity in DIG.

Overview

The ProShares Ultra Energy ETF ( DIG ) is a fund that aims to provide investment results matching twice (2x) the daily performance of the Dow Jones U.S. Oil & Gas Index. This is a leveraged ETF, meaning it uses financial derivatives and debt to amplify the returns of its underlying index. DIG's primary goal is to reflect two times the daily performance of this index by investing in equities and derivatives with similar return characteristics.

The ETF is highly concentrated and targets major players in the industry, particularly companies engaged in activities such as oil and gas exploration and production, integrated oil and gas, oil equipment, renewable energy, pipelines, and alternative fuel production. DIG, previously known as ProShares Ultra Energy, is a leveraged product designed for short-term trading rather than long-term investment. It is important to note that long-term returns may significantly differ from those of the underlying index due to daily compounding. The ETF has a relatively high expense ratio of 0.95%, which represents the annual costs when investing in the ETF. It currently holds $133 million in assets under management ((AUM)).

Holdings

DIG is highly concentrated in Exxon Mobil ( XOM ) and Chevron ( CVX ) , with significant portions of its assets allocated to these two energy giants (over 30%).

Other notable holdings include E OG Resources ( EOG ), which specializes in the exploration, development, production, and marketing of crude oil and natural gas. It also includes ConocoPhillips ( COP ), an international energy company involved in the exploration and production of oil and natural gas. Schlumberger N.V. ( SLB ) makes up the fund's fifth largest holding, being the world's leading provider of technology for reservoir characterization, drilling, production, and processing to the oil and gas industry.

The companies within DIG reaped the benefits of elevated oil prices, which stemmed from a V-shaped global economic rebound following the Covid crisis and a heightened demand for oil and gas. Based on traditional valuation metrics, the stocks remain undervalued when considering their P/E ratios. All of them are trading at a multiple of 11 times forward earnings, with the sole exception being ConocoPhillips, which trades at a slightly higher 13 times forward earnings. However, it is important to note that these valuations consider current energy prices. If a steep recession strikes, as during the COVID-19 pandemic, oil prices will likely drop and earnings will be adjusted downward.

Performance

DIG ETF underperformed the broader market in the first half of 2023, as large-cap technology stocks outperformed due to rising AI growth hopes. Since large-cap tech names such as Microsoft ( MSFT ), Apple ( AAPL ) and Alphabet ( GOOGL ) make up the majority of the S&P 500 ( SPY ) weight, and surged over the past year, the ETF is up 12%. This compares to DIG, which returned -7% in the past year.

Last year witnessed a significant decline in oil prices, dropping from nearly $100 per barrel to below $70. Although there's been a rebound due to OPEC's production cuts , oil prices remain 3% lower year-over-year. Given the close relationship between oil prices and the earnings of DIG's constituents, the ETF hasn't generated a positive return in the past year. Thus, similar ETFs, which focus on energy, such as Energy Select Sector SPDR Fund ETF ( XLE ) and Vanguard Energy ETF ( VDE ) could barely generate a positive return over the past year, too. XLE tracks the Energy Select Sector Index and provides exposure to the energy sector of the U.S. equity market. It's one of the most widely recognized energy ETFs. The ETF has very similar holdings and also places the most weight on Exxon Mobil and Chevron, accounting for nearly 40% of the total weight. However, in comparison to DIG, it has an expense ratio of just 0.1%, which is significantly lower. The ETF is unleveraged, meaning it will have less volatility than DIG.

VDE ETF tracks the MSCI US Investable Market Energy 25/50 Index, offering broad exposure to the energy sector. VDE's holdings are nearly identical to XLE, which explains the almost identical performance, although there are slight variations in terms of rotation, which explains the slight divergence in performance. The ETF also has an expense ratio of just 0.10% and a Distribution Yield of 3.3%, which represents the annual dividend of the ETF. The distribution yield helped both VDE and XLE to generate a positive return over the past year.

Since DIG is leveraged, it does not have a significant distribution yield and thus, pays out an annual dividend of just 0.33%.

Takeaways

Being leveraged, DIG can amplify gains during favorable market conditions but can also magnify losses when the market is against it, making it riskier than standard, non-leveraged ETFs. It's mainly used by traders aiming to capitalize on short-term movements in the oil and gas sector. Thus, it isn't typically recommended for long-term investors due to the potential compounding effects that can erode returns over extended periods.

For long-term investors interested in the U.S. energy sector, the high expense ratio of 0.95% for DIG might prompt consideration of more cost-effective alternatives, such as the Energy Select Sector SPDR Fund ((XLE)) or the Vanguard Energy ETF ((VDE)), which additionally offer a continuous dividend yield. However, for short-term investors speculating on a surge in oil prices in the near to mid-term, influenced by global conflicts and production cutbacks, DIG could present an opportunity.

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