Reacting to Oil Crisis Could Be Risky Venture

The events triggered by Iraq’s invasion of Kuwait have made big stock market winners out of certain energy companies. Since midyear, the seven largest oil stocks have gained about 13% on the average. Energy-service firms have done even better.

For mutual fund investors, there are several ways to capitalize on--or at least hedge against--the possibility of higher oil prices. Lipper Analytical Services counts 17 natural resources funds. Virtually all have significant oil or gas exposure, and about half invest almost exclusively in energy stocks. These latter, relatively pure energy plays are about the hottest things around right now.

But that doesn’t necessarily mean you should buy one.

The problem is that energy funds and other types of “sector” portfolios carry above-average risks. Because they focus on a particular group of stocks, sector funds will tend to rise or fall with that industry, not the general market. The managers have fewer companies to choose from, and they usually must stay fully invested in the industry, regardless of the outlook.

Sector funds also attract more short-term traders, who can cause fits for portfolio managers if they suddenly decide, like a bunch of lemmings, to get out all at once. A wave of investor redemptions can force a manager to liquidate stocks whether he wants to or not, and that can hurt the remaining shareholders.

It’s not uncommon for sector funds to rise or fall by 15% or more over a three-month span. “These aren’t investments that you can buy and forget about,” warns Stephen L. McKee, editor of the No-Load Mutual Fund Selections & Timing newsletter in Dallas.

Besides, if you keep your eyes open, you can find broadly diversified growth portfolios that have taken a large weighting in energy issues.

For example, the Lindner Fund of St. Louis has about 10% of its assets in four large oil companies and another 30% in cash. This composition helped buffer the fund against the big market drops of the past two weeks. “I wouldn’t rush out and buy oil stocks at the moment since they’ve run up so quickly, but the long-term outlook is pretty good,” says Robert Lange, a portfolio manager for Lindner.

However, sector funds offer one key advantage: They allow you to take a large stake in an industry for which you might have a strong investment conviction.

“What I like is that you can separate certain areas from the rest of the market,” says Cato B. Ohrn, editor of the Sector Funds Newsletter in Escondido. “You know exactly what you’re buying.”

And at the moment, the energy-related group is hot. With oil prices now hovering above $25 a barrel--up from the $15.50 range at the end of June--the prospects for many energy companies have improved substantially.

Ohrn recommends both Financial Strategic Energy and the red-hot Fidelity Select Energy Service Portfolio, which has risen about 14% over the past five weeks. Energy-service companies build offshore platforms, assist in drilling and provide other types of equipment and specialized assistance to oil companies. They also help firms in natural gas, coal mining and related businesses. Leading companies include Schlumberger, McDermott International, Halliburton and Baker Hughes.

The higher oil prices will greatly help energy-service firms, many of which were hit hard during the oil slump that started in 1986.

So might the recent improvement in relations with the Soviet Union. “The Soviets are the largest producer of oil, yet they don’t know how to run their industry,” Ohrn says. He figures American energy-service firms will win contracts to help boost hydrocarbon output in the Soviet Union.

In fact, Ohrn considers energy service one of the four most attractive industrial sectors for the 1990s, along with health care, telecommunications and pollution control. “The fundamentals are so good I don’t see how you can miss over the next 10 years,” he says.

Other energy funds might hold a few service stocks, but they mostly invest in oil companies, especially the larger ones. There’s one exception to this preference for oil: Rushmore American Gas Index has the unique approach of buying only natural gas firms, particularly those engaged in the distribution and transmission of the fuel.

Those natural resources funds that don’t invest predominantly in energy nevertheless take big stakes in the industry. For example, T. Rowe Price New Era, the oldest and largest such fund, has about 29% of its assets in oil stocks, 31% in other resources companies and 13% in gold mining shares, which also tend to rally when oil prices head higher. “The fund is designed as a hedge against accelerating inflation,” explains George Roche, one of New Era’s portfolio managers.

Because of their greater diversification, natural resources funds aren’t as volatile as pure energy portfolios. On the other hand, they haven’t benefited as much from the spike in oil prices. New Era, for example, is up only about 1% since July 1.

As yet another way to capitalize on higher oil prices, consider a closed-end energy fund. Closed-end portfolios are similar to mutual funds in that they feature professional management and diversified holdings. But they trade like stocks, at prices that usually don’t coincide with the per-share value of the stocks or bonds held. In other words, closed-end funds sell at either a premium or discount to their net asset values.

Petroleum & Resources Corp., a closed-end energy fund that trades on the New York Stock Exchange, has moved higher over the past few weeks. At last count, the fund sold at a slight 6% discount to its holdings, compared with a 13% gap earlier this year. That indicates the fund is becoming more expensive.

Because so many energy-related funds have surged in recent weeks, Ohrn suggests a “dollar cost averaging” strategy in which you purchase shares in small, fixed amounts spread over several months or longer. That way, you get a blending of prices, which should help alleviate any anxiety that you might be buying at a peak. Ohrn says dollar cost averaging works best for broadly diversified funds or long-term growth sectors--a category that he feels describes the energy-service business.

By contrast, McKee doesn’t recommend any energy-oriented mutual funds. “I hate to chase after investments, and oil has had an incredible rise lately.”

He believes gold funds offer a better way to capitalize on higher oil prices, rising U.S. inflation and heightened international tensions. “If the situation in the Persian Gulf worsens, gold will probably do better than oil,” he predicts.

Lately, gold has risen about 8% from its July low near $350 an ounce, sparking a rally in gold funds. McKee’s favorites include the Benham Gold Equities Index Fund of Mountain View, Calif., and Financial Strategic Gold of Denver.

Gold portfolios are yet another type of sector fund and, like the others, should be handled carefully. McKee cautions against placing more than 15% of your investment portfolio in any sector fund, and he suggests selling if prices start moving sharply against you.

HIGH-OCTANE FUNDS

Rising oil prices bode well for energy stocks. Here’s key information on a dozen of the biggest and best-performing mutual funds that concentrate on the industry.

Total Return Sales Fund 5-Year 1-Year Charge Minimum Dean Witter Natural Resource +93% +14% None* $1,000 Fidelity Select Energy +78% +18% 2%* $1,000 Fidelity Select Energy Service -- +43% 2%* $1,000 Financial Strategic Energy +85% +11% None $250 Merrill Lynch Natural -- +19% 6.5% $500 Resources A Merrill Lynch Natural -- +17% None* $500 Resources B New Alternatives +107% +9% 5.66% $2,650 Plymouth Global Natural -- +20% 4% $1,000 Resources Putnam Energy-Resources +85% +17% 5.75% $500 Rushmore American Gas Index -- +11% None $1,000 T. Rowe Price New Era +103% +10% None $2,500 Vanguard Specialized Energy +121% +22% None $3,000 Lipper All Equity Fund Average +93% +13%

Fund Phone Dean Witter Natural Resource (800) 869-3863 Fidelity Select Energy (800) 544-6666 Fidelity Select Energy Service (800) 544-6666 Financial Strategic Energy (800) 525-8085 Merrill Lynch Natural (800) 637-3863 Resources A Merrill Lynch Natural (800) 637-3863 Resources B New Alternatives (516) 466-0808 Plymouth Global Natural (800) 544-6666 Resources Putnam Energy-Resources (800) 225-1581 Rushmore American Gas Index (800) 343-3355 T. Rowe Price New Era (800) 638-5660 Vanguard Specialized Energy (800) 662-7447 Lipper All Equity Fund Average

* Dean Witter Natural Resource and Merrill Lynch Natural Resource B charge back-end loads ranging as high as 5% and 4%, respectively. The Fidelity Select funds have 1% redemption fees.

Total return figures are for periods ending June 30, 1990

Source: Lipper Analytical Services

HOW MUTUAL FUNDS PERFORMED

Average total return, including dividends, in percent for periods ended Thursday, August 9.

TOP 10

Fund Type Notes 12 mos. Yr. to date Strategic Gold/Minerals AU L -3.00 % +11.70 % Schield Portfolio: Aggr. Growth CA LL +13.80 +14.94 Sherman, Dean Fund CA NL -12.26 -12.35 First Australia: Income Fund WI L * +9.89 Dreyfus Capital Value Fund CA LL +1.81 -2.60 Strategic Investments AU L -2.97 -28.21 Dreyfus Strategy World Revenues WI LL -0.07 -4.35 First Australia: Pacific Rim PC L * +0.55 First Australia: Aust.$ Liquidity WI LL * +9.11 U.S.: Gold Shares AU NL +10.41 -19.07

Fund Week Strategic Gold/Minerals +5.26 % Schield Portfolio: Aggr. Growth +2.84 Sherman, Dean Fund +2.40 First Australia: Income Fund +2.31 Dreyfus Capital Value Fund +2.25 Strategic Investments +1.95 Dreyfus Strategy World Revenues +1.94 First Australia: Pacific Rim +1.73 First Australia: Aust.$ Liquidity +1.71 U.S.: Gold Shares +1.20

BOTTOM 10

Fund Type Notes 12 mos. Yr. to date Tyndall-Newport: Tiger Fund PC L +5.55 % -2.55 % Financial Portfolio: Pacific PC NL -1.20 -9.68 Fidelity Pacific Basin PC LL -9.32 -14.18 T Rowe Price Intl.: Discovery Fd. IF NL +28.77 +7.65 SLH Investment: Pacific Portfolio PC NL,R -22.01 -26.54 Tyndall-Newport: Far East Fund PC L -3.64 -8.51 DFA Group: Japanese Small Company PC LL -3.65 -18.77 Fidelity Select Transportation S LL,R -13.05 -9.67 Prudent Speculator: Leveraged SG NL -34.76 -21.37 G.T. Global: Pacific Growth Fund PC L +11.91 -3.57

Fund Week Tyndall-Newport: Tiger Fund -12.80 % Financial Portfolio: Pacific -9.22 Fidelity Pacific Basin -9.20 T Rowe Price Intl.: Discovery Fd. -9.11 SLH Investment: Pacific Portfolio -9.03 Tyndall-Newport: Far East Fund -8.75 DFA Group: Japanese Small Company -8.55 Fidelity Select Transportation -8.55 Prudent Speculator: Leveraged -8.46 G.T. Global: Pacific Growth Fund -8.37

TYPE: AU = gold, B = balanced, CA = capital appreciation, CV = convertible securities, EI = equity income, EU = European regional, FI = fixed income, FS = financial securities, FX = flexible portfolio, G = growth, GI = growth and income, GL = global-international and U.S. stocks, GX = global flexible portfolio, H = health/biotechnology, I = income, IF = international, MI = mixed income, NR = natural resources, OI = option income, PC = Pacific regional, RE = real estate, S = specialty/misc., SG = small company, TK = science and technology, UT = utility, WI = world income.

NOTES: NL means no sales charge, LL means sales charge of 4 1/2% or less; L means sales charge of greater than 4 1/2%; R means redemption fee may apply.

* Fund not in existence for the period covered.

Source: Lipper Analytical Services