Darius McDermott: How to invest in oil

Oil's been something of a trendy buy among more adventurous investors this year and while there's a lot of commentary about arguing for both the bull and bear case, it's been harder to find good advice on the best way to actually buy the stuff.

If you've got some oil enthusiasts among your clients, who are asking the question, the answer is more complex than you might initially think.

Earlier this year, I myself was one of those who wanted to 'take a punt'. The spot had fallen to below US$30 a barrel. I could only see it going up from there - at least over the long term - so I thought "great, I'll buy some oil now and sell up in a year's time to make a tidy profit".

 

'In contango'

Obviously not wanting to take delivery of a hundred physical barrels, I looked to exchange traded products (ETPs). Globally there are more than 2,000 crude oil ETP securities on the market, according to Bloomberg data, so I had no shortage of choices.

But what I learned is that the performance of these securities rarely matches the spot price.

The problem is that these ETPs deal in futures contracts, not spot prices. With oil so low, futures are consistently much higher than the spot at the moment - a situation that is known as being in contango.

What it effectively means is that you buy an ETP that is already more expensive than today's price. Ultimately, when futures are in contango, it is very difficult for a commodity ETP to make a decent return.

Your other option to get exposure to oil upside, therefore, is to buy energy equities.

Obviously not wanting to take delivery of a hundred physical barrels, I looked to exchange traded products

Again, you could go the passive tracker route. But because trackers are capitalisation weighted, investors have no control over how much of their money is put into the mega-caps at the top end of the index, which may have less opportunity for growth, versus some of the more 'exciting' small to medium-sized businesses.

You could alternatively buy individual equities, sussing out the more promising opportunities yourself. The only challenge here is that it might be a bit of a stretch from merely thinking you'd like to gain access to a potential rise the oil price, to having the level of knowledge needed to analyse specific energy stocks and choose between them. You also risk a lack of diversification.

 

Greater returns

An option I often suggest, therefore, is to invest in a global energy equity fund. I like Guinness Global Energy. Its specialist managers have built a portfolio that includes some of the stronger performing, income-focused large caps, as well as a judicious selection of smaller holdings that they believe have the potential to generate greater returns if we do see some more oil upside in the coming year.

Given most of the oil majors have just last week reported substantial drops in half-year results on their 2015 figures, this stock selection element is, to my mind, more important than ever.

Oil prices are heavily sentiment driven and can swing wildly. The very turbulent nature of many of the world's major producers leaves supply constantly vulnerable to sudden shocks, be they geopolitical, environmental or related to civil unrest.

While you might not be able to offer your clients a crystal ball in terms of market movements, you can at least help them to make decisions that will put them in the best place to profit if oil goes up.

Darius McDermott is managing director at FundCalibre

 

 

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• Topics
• Commodities
• Darius McDermott
• FundCalibre
• oil
• Exchange-traded product (ETP)