Inflation doesn’t hit all investments equally. Bonds tend to suffer because their fixed payments lose purchasing power as prices rise. Growth stocks also struggle, since rising interest rates reduce the present value of future earnings.
But some sectors benefit from inflation. Certain types of stocks actually thrive when prices go up. These are often called inflation hedges. And if you’re worried about new rounds of tariffs pushing input costs higher, allocating to these stocks can make a lot of sense.
One exchange-traded fund (ETF) that stands out for this role is the iShares S&P/TSX Capped Energy Index ETF (TSX:XEG). Here’s how it works and why I like it.
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What is XEG?
XEG is a straightforward way to gain exposure to Canada’s largest energy producers. It tracks the S&P/TSX Capped Energy Index, which includes major Canadian energy companies but limits the weight of any single stock to 25%. That keeps the fund from being too top-heavy or dominated by one or two players.
Importantly, XEG is purely focused on the upstream side of the energy sector. That means it holds exploration and production companies, which are businesses that drill for oil and gas, bring it to the surface, and sell it into global markets. You won’t find any midstream players that focus on pipelines or transport infrastructure, nor any downstream firms involved in refining or retail.
That upstream focus is key. These companies tend to benefit directly when oil and gas prices rise, which often happens during inflationary periods. That makes XEG particularly well-suited as an inflation hedge, since the businesses it holds are tied closely to commodity prices, not consumer demand. In 2022, when inflation struck, XEG returned 53.17%!
Other tidbits to know
Canadian energy stocks have been generating strong free cash flow in recent years. That surplus cash has led to a wave of buybacks and dividend increases across the sector, and XEG’s dividend reflects that. The fund pays quarterly, and its most recent June payout was $0.182 per share.
If we annualize that single payout, assuming it stays consistent, you’re looking at a forward yield of about 4.21% based on current prices. But energy prices and dividends can swing, so a better gauge is the 12-month trailing yield, which sits at around 3.67%.
That’s still a strong yield for a sector ETF, especially one that also offers inflation protection. It’s not free, though. XEG charges a 0.60% management expense ratio, meaning you’ll pay $60 annually on every $10,000 invested.
Still, for investors looking to protect purchasing power and collect some income along the way, XEG is a clean and efficient way to do both. Plus, it’s a great complement if you already own some pipeline stocks that it lacks.
