A Compelling Nuclear Energy Play

Last summer I wrote on RealMoney about the then-new Market Vectors DAX Global Nuclear Energy ETF ( NLR). Since listing, NLR has been successful at drawing funds, as it has increased to $197 million in assets, which is solid for such a new fund.

The case for nuclear was compelling when I wrote that first article and is all the more so now with oil trading well above $120. There are over 400 nuclear plants in the world with plans for that number to increase by 50% in coming years. If that trend plays out as people expect, then the stock's underlying nuclear energy funds will participate in that growth and presumably that should mean good things for the prices of these companies.

Last month, the PowerShares Global Nuclear Energy Portfolio ( PKN) came on the scene to provide some competition for NLR. There is some overlap between the two but there are some differences that could matter in the long term. For now, after just a few weeks of trading, the differences have not mattered at all.

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There aren't too many similarities, but they include 28% allocations to Japan (mostly industrial conglomerates that are one way or another involved with nuclear plant construction) and 12% allocated to France (split between Electricite De France and Areva).

The differences include PKN being much heavier in U.S. stocks at 35% vs. 20% for NLR, which seems to generally equal weight mining stocks at 33%, utilities at 32% and industrials at 30%. PKN allocates 47% to industrials, 24% utilities, 15% to mining/energy along with an almost 10% weight to technology.

NLR has a smaller average market cap of $9.5 billion vs. $30 billion for PKN. The two funds only share four of their respective top 10 stocks in common. The difference in mining sector weights also affects the country allocation, with PKN at 11% Canada and 4% Australia, while NLR weights them at 18% and 10%, respectively.

One last statistical nugget is that PKN has a slightly higher expense ratio of 0.75% vs. 0.65% for NLR.

Both nuclear funds have the word energy in their names but are heaviest in industrial, mining and utility stocks. This raises the question of what part of a portfolio should either nuclear fund be considered?

It seems pretty clear that PKN will have a high correlation to NLR (this has been the case thus far and given the overlap that should continue). Since its inception NLR has had a 0.748 correlation to iShares Global Materials ( MXI), a 0.698 correlation to iShares Global Energy ( IXC), a 0.652 correlation to iShares Global Industrials ( EXI) and a 0.607 to iShares Global Utilities ( JXI). (All correlation numbers from PortfolioScience.com.)

This implies that for anyone building a portfolio from the sector level, which is how I do it, the nuclear funds might be best thought of as part of the materials sector allocation. It will be interesting to see if this stands up for PKN given its smaller allocation to mining stocks, but in the last month PKN correlates most closely to MXI compared to the other sector ETFs.

One last point to make about NLR, and I believe this will be the case with PKN, is that the nuclear energy theme is very volatile. NLR has had a standard deviation of 30.5 vs. 19.64 for the S&P 500. From early November to mid-January, NLR fell by 35% while the S&P 500 fell about 15%. Regardless of your opinion of the fundamentals of nuclear energy, that sort of swift decline could repeat in the future.
At the time of publication, Nusbaum was long JXI, MXI and IXC in client holdings, although positions may change at any time.

Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback; click here to send him an email.