DRLL ETF: Drilling A Duster (NYSE:DRLL)

In oil and gas industry slang, “drilling a dust” refers to a dry hole without economic quantities of hydrocarbons. The more I look into the Strive US Energy ETF (NYSE: DRLL), even more so I remember this slang.

Last year, when we initiated coverage of the DRLL ETF, we questioned the differentiator between DRLL’s portfolio methodology and cheaper alternatives such as the Energy Select Sector SPDR Fund (XLE). In addition, we showed that the corporate governance strategy of the highly popular DRLL was not significantly different from how other ETF managers vote on ESG issues. In this article, I want to review the changes made to DRLL’s mandate as well as the fund’s performance as the fund has been running for over 2 years.

In April, DRLL changed its benchmark from Solactive United States Energy Regulated Capped Index t TO Bloomberg US Energy Select Index. More importantly, the fund’s updated prospectus removed references to the fund’s “anti-ESG” proxy voting guidelines. Has Strive run out to grow assets under management?

In addition, there is persistent underperformance of DRLL compared to peer energy funds. Since inception, DRLL has underperformed by 12-13%.

With its questionable mandate and poor performance, I still recommend investors avoid this fund.

Brief overview of the fund

The Strive US Energy ETF’s claim to fame is founding asset manager Vivek Ramaswamy. Mr. Ramaswamy rose to national prominence on the basis of his “anti-awakening” political stance. The DRLL ETF’s stated goal is to “unlock value in the US energy sector by forcing companies to focus on excellence” over politics (Figure 1).

Strive Asset Management aims to “prioritize the shareholder over other stakeholders” by rejecting the tendency of large asset managers to “(incorporate) non-monetary factors under the guise of considering environmental, social and governance risk factors”. The DRLL ETF is marketed to investors fed up with ESG propositions that have been “crammed down investors’ throats by fund companies and the media”.

DRLL currently has $324 million in AUM and charges an expensive expense ratio of 0.41% (Figure 2).

Similar funds such as the XLE ETF and the Vanguard Energy Index Fund ETF (VDE) charge 0.09% and 0.10%, respectively (Figure 3).

Removing anti-ESG voting policies from the prospectus?

In my previous article, I noted that one of DRLL’s “characteristics” is the fund’s “anti-ESG” proxy voting guidelines. As stated in the fund’s original prospectus, ETF DRLL will use its proxy voting powers to vote “in favor of board members and proposals that the firm believes will lead the companies to be mission-driven, customer-centric , innovative, merit-based, and financially disciplined”. DRLL ETF “will vote against proposals and board members that the firm believes will not best advance these objectives.”

However, on 11 April 2024, the DRLL ETF changed its fund benchmark from Solactive United States of America Energy Regulated Capped Index TR TO Bloomberg US Energy Select Index. With the change to its benchmark, the fund’s updated prospectus no longer includes specific proxy voting guidelines.

While the waiver of proxy voting guidelines may be a filing oversight, it could also reflect a change in the fund’s mandate. According to Strive’s new CEO Matt Cole, Strive was seen as overly political, “turning off some investors and limiting its growth opportunities.” The firm needed to “recalibrate(s) the anti-wake meter” to increase assets under management. In other words, Strive may have “sold” the “anti-ESG” investor base.

DRLL sells a compelling story…

Instead of focusing on the political and culture war, Mr Cole wants DRLL investors to focus on the attractive investment opportunity available in US energy companies. A widening shortfall in oil and gas investment could lead to higher energy prices and windfalls for the industry, according to JPMorgan analysts.

Essentially, energy companies trade at less than half the P/E of the S&P 500, but have grown earnings nearly 5 times the market over the past 4 years (Figure 4).

On a relative basis, Strive believes that energy company valuations are structurally cheap compared to the technology sector. A reversion to the historical average could see energy valuation multiples expand by 3.5x (Figure 5).

…But parity can be a wish…

Regarding the ratings, I have to agree with the managers at Strive. The US energy sector, which trades at a Fwd P/E of ~12x, looks compelling compared to the market at 21x (Figure 6).

However, one caveat to the multiple expansion thesis is that the energy sector is notoriously cyclical, with operating earnings often dipping into negative territory during economic slowdowns and recessions (Figure 7). So it might be delusional to think that energy should trade at par with tech, which has seen almost non-stop earnings growth.

…And is DRLL the right tool to capture energy with advantage?

In addition, the question arises as to whether DRLL is the most suitable investment to capture the profit in the energy sector. In my last article, I noted that DRLL underperformed the XLE and VDE ETFs by a few percentage points early on. Unfortunately, the performance gap widened to a chasm over the past year as DRLL performance continued to lag behind, with DRLL returning 0.3% versus 6.6% for XLE and 5.8% for VDE (Figure 8).

This increased DRLL’s early underperformance to over 13%, with DRLL returning 15.0% compared to XLE’s 28.2% and VDE’s 27.1% (Figure 9).

Looking at the details, it is not clear why DRLL performs so poorly, because the main holdings of DRLL (Figure 10) are very similar to those of XLE (Figure 11) and VDE (Figure 12).

Conclusion

In summary, the Strive US Energy ETF claims to unlock value through superior corporate governance practices. However, a review of DRLL’s updated prospectus suggests that the fund may have changed its proxy voting guidelines to be less “anti-ESG”.

Additionally, looking at DRLL’s performance, we see perpetual underperformance relative to more established and cheaper alternative funds such as XLE and VDE.

Even though I’m personally bullish on the relative valuation of the energy sector, I wouldn’t recommend that investors express it through the DRLL ETF. I continue to advise investors to avoid this fund.