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Use
Mutual Funds to Invest in Oil
Do you think oil prices are heading down
anytime soon? Me neither!
If it’s true that high oil prices have become a fact
of life, this may be a good time to check out investing opportunities in
the oil sector. Here are some ideas for doing it with mutual funds.
Mutual funds offer advantages over individual stocks
in instances such as this when you’re expecting an entire sector to move
up.
When you buy a fund, you are, in effect, hiring the
fund manager whose day job is tracking of changing market conditions.
Also, since most funds own dozens, if not hundreds of stocks, you’ll enjoy
the advantages of automatic diversification. That way, one bad stock won’t
ruin your returns.
Screen for Best Prospects
I used Morningstar’s free mutual fund screener to find the mutual
fund candidates in the energy sector. If you’re not familiar with the
term, a screener is a program that scans through the entire universe of
stocks or mutual funds to find those meeting your specific requirements.
I picked Morningstar’s fund screener because it’s
free and anyone, even the most technically challenged, will find it easy
to use. Get there from Morningstar’s homepage (www.morningstar.com)
by selecting
Funds, and then
Mutual Fund Screener listed under Morningstar Tools. I’ll describe my
screen, but you may want to alter my requirements to suit your needs.
Select Screening Criteria
Start by using the Morningstar Category dropdown menu to select
Specialty—Natural Resources, which rules out all funds except those
holding mostly natural resource stocks.
Next, use the Load Funds dropdown menu to specify,
“No-load funds only.” Loads are charges subtracted from your investment,
usually when you purchase a fund, to pay the broker or investment advisor
who recommends the fund. Since these charges reduce your returns, there’s
no point in paying a load if you’re picking funds on your own.
Morningstar rates funds from one to five stars, where
five is best. The ratings compare historical returns to historical
volatility (risk). Use the Ratings and Risk checkboxes to require
Morningstar four- or five-star rated funds. By limiting your selection to
four stars or better, you’re avoiding the highest risk funds.
Finally, use the YTD (year-to-date), 1-Year Return,
3-Year Return, and 5-Year Return dropdown menus to specify “greater than
or equal to category average” for each of the four timeframes. By doing
that, you’re limiting the field to funds that have consistently
outperformed the natural resources category average for at least the past
five years.
The 5-year requirement precludes funds that haven’t
been in existence that long. However, the oil sector only started
outperforming around two years ago. By adding the 5-year requirement,
you’re limiting the field to funds that outperformed when the sector was
in the doldrums, as well as during boom times. That gives you some
insurance, just in case we’re wrong, and oil prices go down instead of up.
Delete the 5-year requirement if your screen doesn’t turn up enough funds.
Look at Historical Returns
After you’ve entered your search rules, click on Show Results to
see the list of passing funds. Use the dropdown menu to change from the
default Snapshot display to the Performance view, which lists the
year-to-date and average annual returns for periods up to 10 years, if the
fund has been around that long.
Morningstar listed eight funds when I ran the screen.
However, on inspection, I found that five (AIM Energy, Ivy Global Natural
Resources, Ivy Global Natural Resources A, Jennison Natural Resource, and
Van Eck Global Hard Assets) were either closed or not available through
discount brokers.
Only Three Survivors
That left me with three available funds, ICON Energy (ticker symbol
ICENX), U.S. Global Investors Global Resources (PSPFX), and Vanguard
Energy (VGENX). Vanguard Energy requires a $25,000 opening investment,
which may be too high for many investors. U.S. Global requires $5,000 but
you can start with the ICON fund with only $1,000 (Disclosure: I control
positions in the ICON and Vanguard funds).
Of the three, according to Morningstar, U.S. Global
Investors, which averaged an eye-popping 56%
average annual return over the past three years, and 40%
annually over five years, has been the best performer.
Vanguard and ICON both averaged annual returns of 42%
over the past three years, and around 25% over
five years.
What About ETFs?
I also checked the performance of exchange-traded
funds (ETFs) specializing in energy stocks. ETFs are similar to index
mutual funds, except they trade like stocks. I used Morningstar’s ETF
screener (click on ETFs on the top menu, and then select ETF Screener) to
list ETFs in the natural resource category.
Of the 17 ETFs listed for the category, only five
have been around long enough to accumulate three-year track records, and
of those, three have been in existence at least five years.
The energy ETFs haven’t produced returns comparable
to the top performing actively managed mutual funds.
The best ETFs were the Energy Select SPDR fund
(ticker symbol XLE) and the Oil Services HOLDRs fund (OIH). Both averaged
38% annually over the past three years, good,
but far short of U.S. Global’s 56%. Over five
years, Oil Services HOLDRs was the best ETF, averaging 18%
annually, again, not comparable to the top managed mutual funds.
Don't Put All Your Eggs In One
Basket
Some analysts say current oil prices reflect fears
that geopolitical problems will disrupt oil supplies are keeping prices
artificially high. They see prices dropping when these fears subside. Just
in case they are right, don’t put all of your money into energy. A good
rule of thumb is to avoid investing more than 25%
of your capital in any one sector, in this instance, energy.
published 8/6/06 |
