Consider Energy Portfolios as Oil Prices Go Up
Oil prices have been creeping higher in recent weeks, reminding investors that energy mutual funds still exist.
It’s been easy to forget about these wallflowers. Energy funds invest primarily in oil company stocks and thus are partly held hostage to fluctuations in the commodity’s price. Considering that oil sells for less than it did in the early 1980s, it’s easy to understand why the funds have lagged the broad stock market over the last decade.
For the 10 years ending March 30, energy and other natural resources funds rose 176% (10.7% a year, compounded), compared to 325% (15.6% annually) for the average equity portfolio, reports Lipper Analytical Services of Summit, N.J.
Funds in the broader natural resources category invest mainly in energy stocks, along with timber, mining and other inflation-sensitive industries.
Despite the lackluster investment results, there are compelling reasons to consider an energy fund of some type at this juncture--at least for a small portion of your assets. First, the funds stand to gain ground if demand for oil increases as the economy strengthens. “It’s a good bet that commodities in general and oil in particular will be going up later in 1992 and into early 1993,” says George Dagnino, publisher of the Peter Dag Investment Letter in Akron, Ohio.
Actually, energy funds are on a minor roll, having risen about 7% during April and May of this year, compared to 1% for the average stock portfolio, reports Lipper. Whether this advance foretells a larger rally will depend on the direction of oil prices, which have increased more than $2 a barrel in recent weeks.
Second, oil company shares and the funds that own them are still cheap compared to the stock market generally, offering a possible contrarian play, some observers say. “I’ve thought all along that the sector was beat up and the outlook is better for the next several years than for the last several years,” says George Roche, portfolio manager of the T. Rowe Price New Era Fund. The Baltimore-based natural resources portfolio has a 35% exposure to energy stocks.
Fund Profit Alert, a Cincinnati investment newsletter, thinks energy funds have some of the best values in the market. “We contrarians feel strongly that the oil stocks have seen the turning point.”
Third and perhaps most intriguing, energy funds can enhance the diversification of your overall mutual fund holdings. The factors that make these investments shine--higher oil prices, Mideast turmoil, rising inflation--often drag down the rest of the stock market.
Although inflation remains modest, “there’s always the potential for (negative) surprises, and where other funds would be hurt, ours would be helped,” says Roche.
On a more ominous note, Geraldine Weiss, editor of the Investment Quality Trends newsletter in La Jolla, believes that the recent strength in oil stocks could signal an imminent decline in the broad stock market. “Rising oil prices raise the specter of inflation, which in turn suggests an upturn in interest rates,” she says. “This may well be the catalyst of a slippery slide in the stock market.”
In general, energy funds move less in line with the broad U.S. stock market than any equity categories other than the international and gold portfolios, according to Morningstar Mutual Funds, a Chicago research publication. Gold funds are considered one of the best inflation hedges and, at current depressed levels, might also offer good long-term potential. Yet these investments are highly speculative, having lost money in five of the last eight years.
The energy and natural resources funds thus offer a less volatile substitute. Because energy-oriented mutual funds march to the beat of a different drummer, you wouldn’t want to put the bulk of your money in one. Roche considers allocations of 10% to 20% justified. Dagnino recently raised his recommended exposure to 15% of total assets from 10%.
It’s notable that Morningstar doesn’t consider any energy or natural resources funds worthy of its top four- or five-star ratings, reflecting the fact that the funds have trailed the field for so long. But three portfolios have earned three-star ratings: T. Rowe Price New Era (no load; 800-638-5660), New Alternatives (5.66% maximum load; 516-466-0808) and Vanguard Specialized Energy (no load; 800-662-7447).
T. Rowe Price New Era is technically a natural resources fund that invests not just in energy but in other inflation-sensitive commodity industries, such as forest products, gold mining and base metals. New Alternatives is unique in that it buys stocks of companies engaged in solar, geothermal and other alternative fuels, without owning any petroleum or nuclear stocks.
Don’t look to any of these funds as a core investment holding. But for extra diversification, energy portfolios are worth considering, especially if a strengthening economy continues to push up the price of oil.
Oil Moving Up
Energy-oriented mutual funds have rallied in recent weeks as crude oil prices have pushed modestly higher.
