As the price of oil hovers around $50 a barrel, its lowest point in six years, some experts argue that now is a good time to invest in oil-related stocks and funds. But Mike Loewengart, director of investment strategy at E*TRADE Capital Management, LLC, says investors shouldn’t see the relatively low price as a green light to rush into oil investments.
That’s not to say that oil can’t generate a healthy return. In fact, if you had invested $1,000 in an investment tracking the S&P 500 Equal Weight Energy Index on Jan. 1, 2009, when oil was about $35 per barrel, your money would have more than doubled by now — even with the recent drop in prices, Loewengart says.
But the potential for growth comes with the potential for loss, says Loewengart, who has additional advice for those interested in testing the market, perhaps for the first time.
Expect Price Swings
If you invest in oil, expect wide swings in price. For example, in recent months, different experts have predicted that oil may hit $20 a barrel and $200 a barrel.
“Expect volatility,” Loewengart says. “See past what might happen in the short term and focus on the longer term.”
Consider your background, skill sets and how much time and effort you’re willing to put into following your investments, Loewengart says. If you’re not willing to put the time into researching individual stocks or other investments, then broad-based energy related investments are better choices, he says.
For a more conservative move into oil-related investments — and remember “conservative” is relative in this sector — consider investing in the largest players, Loewengart says.
“These relatively stable, diversified production companies didn’t rise as much as the riskier players,” he says. “But they also have fallen only about 10 percent from the peak. They’re more diversified so their price movements are less correlated to the price of oil than the smaller players.”
Options for Dividends
These bigger, diversified companies also are a good option for investors looking for dividends. No matter where the price of oil goes, these companies are likely to maintain regular payouts, Loewengart says.
Another option for those seeking dividends is investing in master limited partnerships (MLP) — in firms that transport and store oil and natural gas. An MLP is a type of limited partnership that is publicly traded. MLPs offer the tax benefits of a limited partnership combined with the liquidity of publicly traded securities.
“MLPs are required to pay out most of their earnings to shareholders,” he says. “Because of that, they produce a very healthy yield. Last year, they were very popular as people searched for yield investments.”
But MLPs are not low risk, he cautions. Prices have dropped about 15 percent from the mid-2014 high, he says. If oil prices continue to drop, producers may demand lower rates for transport, which could impact these energy sector MLPs, he says.
Slightly less conservative are investments in smaller companies that that are either directly or indirectly involved with exploration and production, he says. Because these businesses are more narrowly focused, their securities are more closely correlated with the price of oil, offering larger risk-reward opportunities, he says.
“Small cap players rose almost 400 percent from 20091,” Loewengart says. “Conversely, they have fallen the most. Because they are so closely tied to the price of the commodity, there would be a fair amount of speculation with investing in those companies.”
Moving up the risk ladder, oil-related bonds offer income — along with risk, he says.
“If the price of oil continues to fall, these companies will go out of business,” he says. “In these cases, a bond holder will get nothing or very little.”
When to Hire a Manager
Bond investments in the oil sector are more challenging for individual investors, he says. “These fixed-income markets are pretty opaque,” Loewengart says. “They’re not as transparent as equity markets. They trade differently. A lot of individual investors are not comfortable buying these securities.”
An active manager, however, can “shorten your portfolio, move investments to other sectors and help navigate a changing interest-rate environment. An active manager can add considerable value,” he says.
A Risky Bet
The riskiest oil-related investment of all is betting on the price of oil itself, Loewengart says.
“We would be very hesitant to suggest to a smaller retail investor to make a dedicated bet on oil futures,” he says. “There have been many professionals who have been simply caught off guard by the relatively swift decline of oil in the past few years.”
Investing in the oil sector can generate a good return for your portfolio. A variety of investment products offer many options for investors, Loewengart says, with different levels of yield, diversity, risk and reward. But you should take a long-term view and consider engaging an active manager.