Don't be gamed by the name

Exchange-traded funds (ETFs), especially those based on a loosely defined sector can get confused by how they are marketed and even named. They are made up of numerous components that may not be obvious by how they are described. It’s become all too easy to compare an industry ETF to the broader market to have an instant story. The recent run-up in bank funds being a prime example, but another favorite topic in 2017 is whether coal miners, or more specifically, the VanEck Vectors Coal ETF (KOL), will prosper under President Donald Trump.  

Coal’s fall from grace is a well-known story and has had a predictable impact on the one-and-only coal ETF (a telling fact on its own); from its peak in April of 2011 to the inevitable trough in January of 2016.

In that period, KOL was down nearly 90% while the S&P 500 was up 40%. Meanwhile, clean energy ETFs, one of the oldest being the First Trust Nasdaq Clean Edge Green Energy Index Fund (QCLN), began gathering assets. And while many including QCLN underperformed the broader market, their newfound popularity and relative outperformance of KOL set the story as investors had decided coal was dead and clean energy was the future.

Fast forward to 2016 and the narrative quickly changes as KOL does a smart about-face after bottoming in January and quickly shot up more than 155% heading into election day, leaving the financial media quick to pronounce that coal is hoping for a better tomorrow under a President Trump. But following his victory, the narrative becomes confused as KOL experienced a small bounce that is quickly sold off, while QCLN finds a second gear and proceeds to outperform KOL and the S&P 500 for the rest of the year and throughout the first quarter of 2017. While some were quick to credit the adage, “buy the rumor and sell the fact,” the strong dollar was a more likely culprit.  

KOL is exactly what you would expect at first glance — a highly concentrated portfolio of 28 coal industry stocks, including miners, transportation and even equipment manufacturers. What you might not have expected is that very little of the portfolio is in U.S. stocks, which make up around 16% of the portfolio versus 27% in Chinese names followed by Australia at 18%. Those large foreign positions mean the fund can have an inverse correlation to the U.S. dollar, something demonstrated last fall when the U.S. dollar skyrocketed after Trump’s victory, while KOL hit a speed bump. But not all of last year’s performance by KOL can be attributed to a weak dollar, as nearly every holding delivered double-digit or better performance in 2016. Of course, a huge increase in price of natural gas, coal’s main competitor, may be the largest factor. 

But what about the strong performance of QCLN after the election? There, the answer has less to do with solar panels and wind turbines and more with America’s most famous, albeit not profitable, car company Tesla (TSLA) along with major industry supplier ON Semiconductors (ON), both of which are more than 8% of the portfolio. If you’re thinking we picked on QCLN simply for shock value, think again as TSLA is still seen as primarily a battery manufacturer, hence its inclusion in numerous clean energy funds like the PowerShares WilderHill Clean Energy Portfolio (PBW) or the VanEck Vectors Global Alternative Energy ETF (GEX).  

It can be easy to equate an ETF with a specific industry or commodity, but it is important to check under the hood of those ETFs before jumping to any conclusions. You may find something you didn’t expect, which could provide clues to its true value.