How advisers and clients can roll out the barrel

Production disruption in Canada, Venezuela, Nigeria, Libya and Iraq, coupled with relatively steady demand, is helping drag oil back toward the $50-a-barrel mark.

Brent crude and West Texas Intermediate oil are both back at nearly $50 a barrel

Source: Thomson Reuters Datastream

Investment cuts, falling drilling activity and a long-awaited decline in US oil inventories is also helping to persuade the market that the worst is over for the black stuff, after its plunge from around $110 in 2014 to this year’s winter low below $30.

US oil inventories have started to decline on a week-by-week basis

Source: US Energy Information Administration

Regrettably the oil price is never just the result of simple supply-and-demand economics, as there is a geopolitical overlay here –

  • Within OPEC, Saudi Arabia and Iran are bitter rivals and have different economic agendas
  • OPEC continues to try and reassert its authority over the oil price by making life as hard as it can for the upstart US shale producers
  • Any sign of cross-border military conflict in the Middle East could easily spark off a sudden surge in crude

This dimension may deter advisers and clients from taking too strong, or active, a view on oil, given the number of imponderables. Equally, crude will have to enter almost everyone’s calculations in some way, shape or form, given its influence upon global growth and inflation (and potentially interest rates), as well as certain countries, indices and sectors.

For the moment, markets seem to be treating rising oil prices as good news, perhaps as it suggests the economic environment is improving, is helpful in the fight against deflation and also staves off the risk of a credit event at the banks. Note how the UK banks sector has slavishly followed oil for the past couple of years:

Banks are enjoying oil’s rally as this may lessen the danger of loans to energy firms going bad

Source: Thomson Reuters Datastream

If the recovery in oil prices proves sustainable then there could be a number of potential winners from an investment perspective, although they all come with different risk and return profiles. Advisers and clients can then assess whether any of them fit with their overall strategy, investment goals, target returns, time horizon and appetite for risk.

Equally, if oil rolls back over and heads back toward $30 for whatever reason, “risk off” may become the order of the day once more, assuming the patterns of the past two to three years are maintained.

Weighty considerations

Any adviser or client with exposure to the domestic UK equity market is taking a view on oil, whether they like or not, at least to some degree. Oil stocks represent around 12% of the FTSE 100’s market cap, as well as 6% of its forecast aggregate profits and 19% of expected dividend payments in 2016, according to consensus analysts’ forecasts. They are also expected to generate a hefty 28% of the index’s forecast earnings growth for 2016 and 37% for 2017 – and the higher oil prices go, the greater the contribution.

Oil remains a highly influential sector within the FTSE 100

Source: Digital Look, analysts’ consensus estimates

In acknowledgement of this influence, some advisers may seek to embrace it, if they feel oil can go higher, by taking broad-brush exposure to UK equities.

This can be simply done in three ways:

  • UK equity tracker fund
    BlackRock UK 100 Equity tracker is an OEIC and comes with an OCF of just 0.06%. BP and Shell both feature in its list of top-five holdings with a combined weighting of around 7.1%. The SPDR FTSE All Share ETF performs the same function and also has top-five weightings in BP and Shell. Its OCF is 0.2%.
  • Actively managed UK equity fund
    A lot of the top performers in the UK Equity Income category have low weightings in the oils - indeed their recent outperformance will be based on this to some degree - so they have a big decision to take, as to whether to jump back in or not.

Two funds which already have top-ten positions in both BP and Shell are Schroder UK Alpha Income and Royal London UK Equity Income, so they would be logical beneficiaries if oil continued to rally and dragged the share prices of the majors along for the ride.

The table below looks at the oil weightings and positions in BP and Shell of the ten best performing UK Equity Income funds over the last five years.

Best performing UK equity income funds over the last five years still have limited oil exposure

Source: Morningstar, for UK Large-Cap Blend Equity category.
Where more than one class of fund features only the best performer is listed.

The next table performs the same function but for investment trusts. Only one of the top-ten performers over five years – James Henderson’s Lowland – has a top-ten position in both Shell and BP, so this one could get a boost if oil keeps going or suffer if it slips back.

Best performing UK equity income investment trusts over the last five years still have limited oil exposure

Source: Morningstar, for UK Large-Cap Blend Equity category.

There are two further collective options, although these do focus more closely on oil-related stocks or oil itself, and are therefore inherently more risky, given the still unpredictable nature of the crude market.

  • Energy-themed fund
    One option to consider here is the ETFS US Energy Infrastructure ETF (EPIC code MPLI). Listed on the London Stock Exchange, this tracker follows a basket of 24 American energy pipeline, storage and logistics firms, a lot of whose share prices fell hard and fast alongside the actual oil price. The tracker offers a dividend yield of 5.4% and could make further progress if oil makes additional gains.

ETFS US Energy Infrastructure ETF is rallying alongside oil

Source: Thomson Reuters Datastream

  • Oil tracker
    Advisers and clients may want to avoid stock-specific risk and just follow the oil price. ETFS Crude Oil ETC (EPIC code CRUD) tracks the US benchmark, West Texas Intermediate, and ETFS Brent Crude (EPIC code BRNT) the equivalent European oil benchmark.

Note that both trackers follow a basket of oil futures prices, not the spot price, and both use synthetic replication (derivatives) to achieve this. Besides movements in the oil futures, investors are also exposed to the roll yield and collateral yield for their total return on investment, so this added complication may deter some advisers and clients from getting involved.

AJ Bell Investment Director

Russ Mould’s long experience of the capital markets began in 1991 when he became a Fund Manager at a leading provider of life insurance, pensions and asset management services. In 1993 he joined a prestigious investment bank, working as an Equity Analyst covering the technology sector for 12 years. Russ eventually joined Shares magazine in November 2005 as Technology Correspondent and became Editor of the magazine in July 2008. Following the acquisition of Shares' parent company, MSM Media, by AJ Bell Group, he was appointed as AJ Bell’s Investment Director in summer 2013.