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Different ways of investing in energy

This article is part of
Guide to Energy Investing in the 21st Century

Investors can access energy by ploughing their cash into individual stocks such as BP, Shell, British Gas, a venture capital trust (VCT), an exchange traded fund (ETF) or an actively managed specialist energy fund.

On direct investment in energy companies, Gavin Haynes, managing director of Whitechurch Securities, says this is mainly concentrated in large, dividend-paying stalwarts in the traditional energy markets, many of this were offering attractive returns at the end of 2013 despite lagging the wider recovery.

He says: “The UK stock market recovery has been driven by the smaller and medium-sized companies [and] the larger, blue chip majors... lagged behind, but a number of fund managers are starting to show some interest there.”

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However, Mr Haynes cautions that such investments have high concentration risk and thus for most investors a fund offering diversification across stocks and geographic regions is likely to be more suitable.

On the subject of specialist energy equity funds, Will Riley, co-manager of Guinness Global Energy fund, says energy equities tend to rise in line with structural shifts in energy prices.

In terms of rivals to traditional Oeic funds, Mr Riley warns of specific risks with exchange-traded funds. Passive, index-tracking energy equity ETFs have generally underperformed actively managed Oeics over the long term, he says, while commodity futures and commodity ETFs can see returns eroded by something called ‘contango’.

Contango refers to a situation where the price of a futures derivative is below the current price of the commodity, but people are willing to pay more than the actual expected price due to a desire to avoid paying the costs of storage and buying today.

There are many pitfalls of trying to gain exposure to energy through ETFs, according to Mr Haynes, who again particularly highlights issues with commodities funds that may not “give you a true reflection of the price”.

“I would say unless you have a very good understanding of the spot and futures price and the impact of raw yields then we would say really they are best steered clear of.”

Another alternative is venture capital trusts, many of which specialise in alternative energies such as solar and wind and therefore appeal to ethically conscious investors or those seeking to benefit from a shift in policy focus to renewable energy. VCTs also benefit from 30 per cent income tax relief, potentially boosting - or at least protecting - returns.

There is little doubt that solar, wind and other alternative energy sources will be a source of growth in the future, but fickle government policy, competing technologies and pace of change can make it difficult to predict what to back and when.

Darius McDermott, managing director of Chelsea Financial Services, says: “Energy investments can be very volatile and alternatives especially are very vulnerable to changes in government policy.

“Energy investments can be a good hedge against inflation, though, and if household energy bills are rising, it can be a little comfort that your investment in these companies should be seeing prices rise too.