Mark Dampier: Energy fund suffers in a risky sector

The Analyst

The case for investing in the energy sector is persuasive as global demand continues to grow. Developed economies remain energy-intensive, while emerging ones are striving to industrialise, which consumes even more energy.

On the other side of the equation, supply is constrained. Pressure is building on finite resources such as oil, gas and coal, meaning prices have increased over the long term, though short-term volatility remains. Indeed, energy stocks have had a particularly poor period, which unfortunately coincides with the launch of the Artemis Global Energy Fund in April 2011.

So far, it has been a difficult time for the fund. For one thing, it is positioned differently from its benchmark, which has a high proportion in integrated oil and gas producers. These stocks tend to have an income bias, and have been in favour with investors, given the low rates of interest seen on deposit. The fund is instead skewed more towards exploration and production companies, some of which operate in less developed or more politically sensitive markets.

One such holding that has suffered is Transglobe Energy. Its operations are based in Egypt, and bouts of instability there have contributed to negative investor sentiment. The company, though, has seen strong production growth, and its management remains abundantly positive. This type of company accounts for two-thirds of the portfolio, and also includes firms such as Karoon Gas Australia, Providence Resources and Ithaca Energy.

These companies also tend to suffer when there is little or no news flow, as investors become uninterested, and recently this has been the situation. Despite this, managers John Dodd and Richard Hulf expect a positive news flow in the second half of this year, which they hope will boost share prices.

Exposure to the US shale oil and gas theme has also been increasing after a recent visit to the region. The managers believe an improving US economy will provide a boost, while politicians are also warming to the idea of exporting liquid natural gas.

Elsewhere, UCITS rules permit up to 10 per cent of the portfolio to be invested in unquoted companies. The fund has always been below this limit, holding 4 to 8 per cent in unquoted companies since launch.

One of the largest unquoted holdings is Vostok Energy, where 1.8 per cent of the portfolio is invested. Overall, the position has disappointed as the managers have been forced to write the holding down to zero. All the pain has now been taken, though John Dodd and Richard Hulf still see value in the company and await a potential buyer. The next few months will be vital in determining whether they are correct. This highlights the risks associated with investing in unquoted companies.

Forecasting the price of oil has always been difficult. Many have suggested the oil price should fall given the slowdown in the developed world. Yet, in a globalised world, there are many other factors affecting the oil price. John Dodd and Richard Hulf suggest it is currently high enough for most producers to be making good money. They believe the price is unlikely to fall, as Saudi Arabia and Opec need to keep it above $90 per barrel in order to fund political efforts to stave off their own Arab Spring. Couple this with tensions in the Middle East and the fact the OECD, which has enormous oil reserves, will release supply when the price gets too high, means the market tends to be fairly range-bound.

The Artemis Global Energy Fund has, in fact, fared slightly better than the majority of other specialist energy funds. The problem arises for those investors at launch who have been stuck in one-way traffic and are still nursing a loss. Of course, this is nobody's preference – I own the fund myself, so I understand that all too well. However, John Dodd and Richard Hulf are both experienced and talented managers in this niche area of the market, and I believe they have the ability to turn performance around. Both managers have significant amounts of their own money in the fund and I, too, will be remaining patient for some time yet.

Mark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial advisor and stockbroker. For more details about the funds included in this column, visit www.hl.co.uk/independent

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