Discretionary fund managers are taking a wait-and-see approach to dialling up their limited exposure to oil as prices hit unprecedented negative territory.
Contracts on West Texas Intermediate, the benchmark for US oil, plunged below -$40 on Monday as the coronavirus lockdown created a massive slump in demand compounding the existing supply glut led by Saudi Arabia and Russia. As oil storage reached capacity, traders rushed to exit contracts before taking physical delivery.
Architas senior investment manager Mayank Markanday (pictured) describes this as a “double whammy effect” whereas normally supply drives prices and demand is much more predictable.
Architas awaits more positive signals from oil producers
Architas currently only has exposure to oil through Pimco GIS Commodity Real Return fund, which represents less than 5% of the Diversified Real Assets portfolio. It started the year with more exposure via the Pimco MLP Infrastructure fund but reduced the position over Q1 before cutting it completely in March when the Opec-Russia meeting broke down.
Markanday says while the oil price looks “optically” attractive, there would need to be positive signals coming from the supply side before he considered dialling up exposure in the fund.
Markanday says: “Ideally you need both Opec or Opec+ to make production costs, as well as the US to make production cuts. If that happens, that could be a catalyst for us to become slightly more positive on oil. But at current levels, the volatility and the price has been too risky a trade.
“Trump has talked about filling up his strategic reserves to the maximum level. But I don’t think that’s enough, more needs to be done. The US government basically needs to work with oil producers to shut down production and shut down their wells. And, there needs to be some sort of relief package on the other side of that to support some of these firms.”
Approximately 1.15 million people are employed in the US upstream energy sector with a further 1.4 million working in transmission, distribution and storage.
Equities look through the current oil price weakness
Other investment managers Portfolio Adviser spoke with also had low exposure to the commodity.
Premier Diversified fund manager Neil Birrell says the range’s small exposure to oil was via oil companies and that this week’s events would have little impact on positioning.
Janus Henderson said in a note issued on Wednesday that oil majors such as BP and Shell appeared to signal long-term oil prices at $55 a barrel. “Given renewed OPEC discipline and non-OPEC supply cuts it is reasonable to expect healthier oil prices over the course of the year and into 2021. Equities are forward looking and they have indeed been looking through the current oil price weakness,” said Janus Henderson natural resources senior investment manager Tal Lomnitzer.
Numeg has around 3 to 4% of its equity allocations in the energy sector, says head of investment risk Pacome Breton. “The main contributor is our allocation to the FTSE 100, which has 11.3% in energy, and in the US, the allocation to energy was 4.5% at the beginning of this year.”
High yield and emerging market debt were other areas of the portfolio sensitive to the oil price, Breton says.
Equity income is the primary concern at Hawksmoor Investment Management, says CIO private clients and head of research Jim Wood-Smith.
“Our primary concern is what impact this will have on the dividends to be paid by the major oil stocks, which are typically a major weighting in value and income funds,” Wood-Smith says.
“It is not at all clear what will happen; a reasonable expectation is that payments will be cut by at least half, but it is quite possible that the payments will be passed altogether this year.”
Tilney tends to keep exposure to oil limited throughout the cycle, says head of multi-asset Ben Seager-Scott.
“Overall, our core strategy tends to favour those investing in those higher quality companies that can deliver throughout the economic cycle, and this leads us to generally have only limited exposure to energy at the best of times – often as a tactical position, so at the moment we don’t have very much exposure to energy at all,” Seager-Scott says.
Oil ETPs out of favour with fund pickers
Although Nutmeg currently has no energy sector ETF exposure that could change if oil prices decline to levels “that seem totally unjustified in the mid-term”, says Breton.
The robo-adviser does not invest directly in exchange traded oil products in order to limit the impact of significant price movements on the portfolio. The complexity of the structures, with many being derivatives based, and the cost associated often make them unattractive, Breton says.
Markanday also recommends against buying oil ETPs.
This is because they have large retail ownership that can make them sentiment driven and due to the fact they typically buy front-end contracts, which are more exposed to live crude price and therefore more volatile.
“Whereas if you were to buy an active manager, they can they can pick and choose where on the curve where they want to buy. They could still benefit from an improving outlook for oil, without necessarily the volatility of the front-end contracts,” he says.
UK assets an avenue for multi-asset funds to dial up oil exposure
Sterling, UK equities and value managers are among the ways Architas would dial up exposure to oil in its multi-asset portfolios, says Markanday, if it decides the commodity has become attractive.
you could increase the allocation to value managers. That would benefit from their overweight to the energy sector.
“UK equities, as a whole, if you were to access it in a passive way would benefit, compared to world equities,” he says. “Sterling could also strengthen on the back of oil bouncing, again linked to the fact that the UK economy has a bias to energy.”
He adds: “You could also increase an allocation to a broad-based commodity manager, where energy is going to be a third or a quarter of the portfolio.”
What does negative oil prices mean for decarbonisation?
Hawksmoor is unsure on how the oil price will affect decarbonisation, says Wood-Smith
“It will be easy and cheap for businesses to rely on oil, rather than renewables, for longer; on the other hand, a slow and gradual restart of economies may see a greater willingness for businesses to go straight to renewable power,” he says.
Janus Henderson’s Lomnitzer said low oil prices could accelerate existing trends away from fossil fuels as governments use lower prices unwind subsidies. Fiscal stimulus could also be used to boost clean energy programmes.
The Janus Henderson Global Resources strategy is currently underweight oil producers with a preference for companies benefiting from the carbon transition. It is also invested in shipping, storage and refiners.
But Blackrock Energy and Resources have been adding to energy companies, arguing in a webinar this week that balance sheets were strong and expressing confidence the stock’s would continue to pay their dividends in the near term. That is despite the investment trust announcing in March that it would increasingly be shifting its focus to companies focused on the transition away from carbon-based energy.
The managers expect oil to trade around $20 in the near-term until the coronavirus lockdown is lifted.
