Energy Mutual Funds: Invest Now Or Wait?

Energy mutual funds are an appealing investment option, particularly with the government's increased focus on the energy sector. These funds are thematic, investing in stocks tied to the energy sector, including alternative energy, coal, exploration, oil and gas services, pipelines, refineries, and more. While the energy sector holds promising prospects for long-term growth, it is essential to exercise caution as these funds are subject to cyclical movements and market volatility. Before investing, it is crucial to understand the risks, fees, and historical performance associated with energy mutual funds.

Pros and cons of investing in energy mutual funds

Pros

Energy mutual funds offer investors a way to gain exposure to the energy sector without requiring expertise in crude oil prices and other facets of the industry. They are also a good way to protect investors from external factors that impact energy companies, such as global sanctions and regulations.

Energy mutual funds often offer a broader mix of holdings, particularly those that mimic an index. They can also lessen some of the lockstep movement between stocks and oil prices.

Energy stocks may generate higher returns. One of the advantages of owning individual stocks is knowing the quality and financial outcome of a company, and investors can avoid lower-quality names in a mutual fund.

Energy mutual funds are for a long-term approach. Single stocks of crude oil or renewable energy companies are impacted by external factors such as global sanctions and regulations, which can affect supply and demand and ultimately price.

Energy mutual funds can be diversified. They are a simpler way to diversify a portfolio and carry the advantage of diversification during volatile market times. A diversified fund can reduce an investor's exposure to the negative impact of any specific stock.

Cons

Energy mutual funds may not be suitable for investors seeking oil companies that are only producing free cash flow.

Choosing stocks means devoting time and energy, and investors may gravitate towards familiar names like Exxon Mobil Corp. and Chevron in the energy sector. Individual equities require a thorough analysis of the company's fundamentals, such as management makeup and earnings performance.

There may be barriers to entry for individual retail investors unless they are accredited investors or have a retail broker who can process an investment or trade for them.

It can be challenging to locate and digest correct, comprehensive, and unbiased information about potential renewable energy investments. The terms "ESG", "climate-friendly", and "socially responsible" are often used interchangeably, but they have different definitions and considerations.

Thematic-energy funds explained

Thematic-energy funds are a type of equity mutual fund that invests in stocks tied to a specific theme, such as energy. These funds are considered more broad-based than sectoral funds as they select companies and sectors united by a common idea. For example, a thematic infrastructure fund will invest in stocks related to infrastructure development, including steel, cement and construction sectors.

Thematic-energy funds are high-risk investments as their returns are dependent on the theme playing out as expected. If the theme does not perform as anticipated, the stocks may underperform, resulting in losses. Due to this risk, these funds are only suitable for aggressive or experienced investors with a high-risk tolerance, and even then, allocation to these funds should not exceed 10% of an investor's portfolio.

Thematic-energy funds can be a good option for investors looking for long-term capital appreciation in the energy sector. These funds typically have a minimum investment horizon of five years and can provide diversified exposure to the energy industry. The funds invest in a range of energy-related companies, including those in oil and gas, power, renewables, and energy infrastructure.

Some of the top-performing thematic-energy funds include:

• DSP Natural Resources and New Energy Fund
• Tata Resources & Energy Fund
• ICICI Prudential Energy Opportunities Fund
• SBI Energy Opportunities Fund

These funds have delivered strong returns over the past five years, with average annual returns of around 18-26%. However, investors should carefully consider their risk tolerance and investment objectives before investing in these or any other mutual funds.

Best energy mutual funds to invest in

Energy mutual funds are a great way to invest in the energy industry without having to pick and choose individual stocks. These funds offer instant diversification, investing in a range of energy-related companies, including those in alternative energy, coal, exploration, oil and gas services, pipelines, natural gas services, and refineries.

Fidelity® Natural Resources Fund

The Fidelity Natural Resources Fund seeks capital appreciation by investing primarily in securities of companies engaged in owning, exploring, or developing natural resources. With total assets of $646.88 million, this fund has a strong track record and is a good choice for those looking for capital appreciation.

Vanguard Energy Fund

The Vanguard Energy Fund seeks to provide long-term capital appreciation by investing at least 80% of its assets in the common stock of companies in the energy industry. With a focus on the long term, this fund is a solid option for those looking to invest in energy companies.

BlackRock Energy Opportunities Fund

With total assets of $342.11 million, the BlackRock Energy Opportunities Fund seeks long-term capital growth by investing at least 80% of its total assets in equity securities of global energy companies. This fund is a good choice for those looking for exposure to the global energy market.

DSP Natural Resources and New Energy Fund

The DSP Natural Resources and New Energy Fund is an open-ended equity mutual fund that invests in companies within the natural resources and energy sectors, including oil and gas, metals and mining, renewable energy, and utilities. This fund is suitable for investors with a long-term investment horizon of at least five years and a high-risk tolerance.

Tata Resources & Energy Fund

The Tata Resources & Energy Fund focuses on large-cap stocks in the resources and energy sectors in India. As of January 2024, the fund had a substantial allocation to large-cap stocks (57.54%), followed by mid-cap (26.01%) and small-cap stocks (12.09%). This fund is designed for long-term capital appreciation, making it a good choice for investors with a long-term investment horizon.

SBI Energy Opportunities Fund

The SBI Energy Opportunities Fund is a recent fund offer that aims to provide investors with opportunities for long-term capital appreciation by investing in companies involved in various energy-related activities, including exploration, production, distribution, transportation, and processing of traditional and new energy sources. While it is challenging to predict the performance of this new fund, SBI Mutual Fund has a strong track record with its other mutual funds.

Other Options

Other energy mutual funds worth considering include the Fidelity Advisor® Energy Fund, Fidelity® Select Energy Portfolio, Cavanal Hill World Energy Fund, Guinness Atkinson Global Energy Fund, and energy ETFs such as the Tortoise North American Pipeline Fund ETF and the iShares Global Energy ETF.

Remember, investing in energy mutual funds carries risks, and it's important to do your own research and consult with a financial advisor before making any investment decisions.

Energy mutual funds vs energy ETFs

Energy mutual funds and energy ETFs are both investment options that focus on the energy sector. However, there are some key differences between the two.

Energy Mutual Funds

Energy mutual funds are a type of equity mutual fund that invests in stocks within the energy sector. These funds typically have a broad mandate, allowing them to invest in a range of energy-related industries, including alternative energy, coal, exploration, oil and gas services, pipelines, natural gas services, and refineries. Energy mutual funds can be a good option for investors who want exposure to the energy sector but may be more suitable for those with a long-term investment horizon, as they can be volatile in the short term. Additionally, these funds are considered high-risk and are generally recommended for experienced investors, with a suggested allocation of no more than 10% of a portfolio.

Some examples of energy mutual funds include:

• Fidelity® Natural Resources Fund
• Vanguard Energy Fund
• Tata Resources & Energy Fund
• SBI Energy Opportunities Fund

Energy ETFs

Energy ETFs (Exchange-Traded Funds) are a type of investment fund that holds a basket of stocks in the energy sector. They offer instant diversification and can be bought and sold throughout the trading day, providing more flexibility than mutual funds. Energy ETFs tend to be cheaper than mutual funds and are a good option for investors who want to add energy companies to their portfolio without having to pick individual stocks.

Some popular energy ETFs include:

• Energy Select Sector SPDR Fund (XLE)
• Fidelity MSCI Energy ETF (FENY)
• Invesco S&P 500 Equal Weight Energy ETF (RSPG)
• IShares Global Energy ETF (IXC)
• IShares Global Clean Energy ETF (ICLN)

Comparison

Both energy mutual funds and energy ETFs offer exposure to the energy sector and can be a good choice for investors interested in this area. Mutual funds may be more suitable for long-term investors, while ETFs offer more flexibility and are a good option for those who want to invest in a range of energy companies without picking individual stocks. It's important to note that both options carry risks and investors should carefully consider their investment objectives, risk tolerance, and time horizon before making any decisions.

Risks and rewards of investing in energy mutual funds

Investing in energy mutual funds carries both potential risks and rewards. Here are some key points to consider:

Risks

• Market Price Volatility: Oil and gas prices are highly sensitive to supply and demand and can be volatile due to various geographical, political, and economic factors. Political instability, for example, can significantly impact prices.
• Fraud and Misinformation: The oil industry has seen numerous scams and instances of exaggerated claims about exploration projects. Proper market research is crucial before investing.
• Political Risk: Oil and gas companies often operate in unstable territories, and a sudden political change can disrupt their projects. Investing in companies with partnerships in stable regions can help mitigate this risk.
• Extraction Challenges: Extracting oil and gas is challenging due to terrain and reserve size uncertainties. Investors should carefully study research reports by geologists before committing.
• Accidents and Spills: Oil spills and fire accidents, like the Deepwater Horizon incident in 2010, can cause stock prices to crash and lead to significant investor losses.

Rewards

• Return on Investment: Energy stocks offer lucrative returns, and technological advancements have lowered the risk of investing. Discoveries of massive oil fields can result in steep rises in stock prices.
• Tax Benefits: Income from energy stocks often includes tax-sheltered portions, providing tax advantages to investors.
• Diversification: Investing in oil and gas can provide a hedge against the overall economy. When energy prices rise, other sectors may slow down, so energy stocks can balance a portfolio during economic downturns.
• Stable Income: Oil fields can be profitable for years, providing a long-term stable income source.

Energy mutual funds can be a viable investment option, but thorough research and risk management strategies are essential to navigate the potential challenges and take advantage of the opportunities in this sector.

Frequently asked questions