The energy sector has been gaining ground in recent months after the U.S. oil price rebounded strongly, gaining over 33% from a six-year low of around $45 per barrel hit in January. This is primarily thanks to the billions of dollars in spending cuts, shrinking U.S. oil rigs counts, higher crude oil processing by the U.S. refiners, and consolidation.

Will the bullish trend continue in the coming months too? If we look at the demand/supply trends, demand is definitely on the rise but not enough to meet the growing global supply gut, suggesting range-bound trading for the oil and energy stocks. Additionally, strong dollar has been a major headwind for the oil prices (read: 4 Ways to Short the Energy Sector with ETFs).

Mixed Trends

The peak summer season will drive up the demand for the oil products, in particular gasoline, pushing the energy prices higher. As a result, the International Energy Agency (IEA) raised the global demand growth outlook by 280,000 barrels a day to 1.40 million barrels, bringing total daily demand to almost 94 million barrels for this year. While the agency projects a rise in global demand, oil supplies continue to exceed demand this year.

This is because the Organization of Petroleum Exporting Countries (OPEC) is pumping up maximum oil in more than two-and-a-half years buoyed up by higher output from Iraq and Iran. It is currently producing about a million barrels a day against its target of 30 million barrels a day to protect market share and meet growing demand. Notably, the top oil exporter – Saudi Arabia – has boosted its production to at least a three-decade high.

Further, oil production in the U.S. has been on the rise and reached another record high of 9.6 million barrels per day last week, in more than 40 years. However, it is expected to show some signs of slowdown in June through early 2016. This is especially true as oil production from the seven major U.S. shale plays will likely fall by 1.3% in June and further by 1.6% in July. The latest positive inventory data report from the U.S. Energy Information Administration (EIA) also showed that crude supplies fell for the sixth straight week (ending June 5) (read: Oil ETFs Gain on Lower US Output Outlook).

Given mixed fundamentals, investors are definitely looking for a safe and quality choice in this rebounding sector. While there are several energy ETFs available in the market, Guggenheim S&P 500 Equal Weight Energy ETF (RYE - ETF report) could be an excellent play.

RYE in Focus

The fund offers equal weight exposure to 41 stocks in the basket by tracking the S&P 500 Equal Weight Index Energy. None of the firm holds more than 3.03% of the total assets. In terms of industries, oil, gas and consumable fuels takes the top spot at 70.5% while energy equipment and services account for the remaining portion.

The product gained nearly 6.6% over the past three months, easily outpacing the broad sector fund – Energy Select Sector SPDR (XLE - ETF report) – by over 200 bps. Further, RYE is also leading the way higher from the year-to-date look, with gains of 0.06% against the loss of 1.03% for XLE (see: all the energy ETFs here).

Why RYE is Beating XLE

The outperformance was mainly driven by its equal allocation across various securities, which prevents heavy concentration and provides a nice balance across various securities. With quarterly rebalancing, the product tends to cash in on the overvalued stocks and reinvest in the underperforming ones, potentially allowing outperformance on solid fundamentals.

RYE is also nicely spread out across the two spectrums of market capitalization levels with 52% in large caps and 40% in mid caps. Further, about three-fifths of the portfolio is tilted toward value stocks that appear safe and appealing for investors in a volatile market.

Value investing strategy includes stocks with strong fundamentals - earnings, dividends, book value and cash flow – that trade below their intrinsic value and are undervalued by the market. As a result, value stocks often overreact to both positive and negative news, resulting in movement in the share prices that do not reflect the company’s true long-term fundamentals.

This creates buying opportunities in such stocks at depressed prices and offers the potential for capital appreciation when the stock finally reflects its true market price. As a result, the combination of large or mid-caps and value stocks help to provide stability in the portfolio in an uncertain environment while also offer a significant upside potential when the trend reverses (read: 3 Top-Ranked Large-cap Value ETFs for an Uncertain Market).

While the fund goes a long way in reducing overall risk, investors should note that it is a relatively high cost choice in the space. It charges a bit higher fee of 40 bps compared with the expense ratio of 0.15% for XLE. Further, RYE is illiquid, exchanging just 43,000 shares a day in hand on average suggesting additional cost in the form of bid/ask spread, though it has a decent level of $173.8 million in AUM.   



Bottom Line

Given its equal weighted strategy and diversification benefits, this energy ETF could prove more beneficial to investors compared to the other products in the space. The solid run in the product is expected to continue in coming months even amid volatile oil trading.