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The Crude Effect

In the wake of rising oil prices, benefit by investing in DSP BlackRock World Energy Fund…


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If one looked at the one-year return of DSP BlackRock World Energy Fund as on April 30, 2011, it impressed. It was way ahead of the Sensex and Nifty. In fact, it was higher than the category average of most of the equity funds.

DSP BlackRock World Energy Fund is essentially a fund of funds (FoF) that invests in two international funds: BlackRock Global Funds - World Energy Fund and BlackRock Global Funds - New Energy Fund. The cumulative result on combining the portfolios of both funds is that one can get an exposure to companies in the energy sector across the entire globe.

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However, if investors are excited about having an exposure to companies in the alternative energy space, they would be disappointed to note that the fund has a very limited exposure to the New Energy Fund, the bulk of it goes into the World Energy Fund. Yet, this is not sacrosanct. When the fund was launched in India in July 2009, the allocation between the two funds was much different. Between August and December 2009, the exposure to the New Energy Fund hovered at 30 per cent levels. A sudden and dramatic change took place the very next year. In March 2010, exposure to the New Energy Fund dropped to 4.70 per cent from 26 per cent in the previous month. Since then it has stayed low. But while the allocation to the funds has differed, investors need not fret about large cash exposures. The fund has always been fully invested in the two global funds.

Portfolio Construction
In the World Energy Fund, investments are made across the full range of fossil fuel-related companies including oil exploration, refining, marketing and service businesses, coal, and gas. The exposure to each sub-sector varies depending on the energy cycle.
The New Energy Fund invests in companies at the global forefront of developing and commercialising new energy technologies. The fund diversifies across renewable energy (wind, hydro, geothermal); alternative fuels (biodiesel, coal-to-liquids); automotive and on-site power generation (fuel cells, electric vehicles); energy storage (hydrogen storage, flywheels); materials technology (superconductivity); and enabling energy technologies (emissions trading, metering). Intra-sector exposure is also kept diversified.
In the case of both the funds, stock selection is based on primary research and the fund managers follow a bottom-up approach. Company meetings and on-site visits are an important part of the research process and are viewed as essential in understanding management strategy and product development. While the criteria would differ between sectors, the focus is on efficient operating companies, sound financials, strong management and on companies with commercial products (specially in the case of the New Energy Fund).
Having said that, the bottom-up approach is framed by using clear top-down themes and market-related assessments. Top-down factors such as the price and direction of crude oil, the global scenario in terms of economic recovery, government policy, security and diversity of energy supply and environmental pressures are all taken into account, though the weightage given to each factor will depend on the fund in question.
The portfolios tend to be very well diversified and are not seen to take undue risks in terms of very strong bets. Besides the number of stocks, they are even well diversified in terms of sector exposure.
The good thing about such a portfolio is the global exposure. For instance, amongst the top 10 stocks, Anadarko Petroleum Corporation is a US-based company, Talisman Energy is headquartered in Canada while Schlumberger Ltd is a French company. The diversification is not just geographical but even sector oriented. Anadarko Petroleum Corporation is an exploration and production firm. Schlumberger Ltd. provides technology and information solutions to oil companies. US-based National Oilwell Varco is a worldwide leader in the design, manufacture and sale of equipment and components used in oil and gas drilling and production.

Before you bit the bullet
This fund is a good option if you want a portfolio exposed to energy-related companies across the world. The brand is extremely well known. As of March 31, 2011, BlackRock’s assets under management totalled US$3.65 trillion across equity, fixed income, cash management, alternative investment, real estate and advisory strategies, making it the world’s largest asset manager.
Despite the global exposure and the well diversified portfolios, end of the day it is a thematic fund. At Value Research, we have always been consistent in our view on this aspect - limit the exposure to such a product to not more than 15 per cent of your overall equity exposure.

Why the hike in crude does not work for Indian companies
The oil and gas industry is broadly divided into Upstream and Downstream. The upstream sector, also referred to as Exploration and Production (E&P), includes the search for oil and gas wells and fields and the subsequent drilling operations. The downstream sector relates to refining, marketing, selling and distribution of the products.
A rise in the price of crude should translate into a profit growth for upstream companies due to increased realisations and for downstream companies by improving refining margins. However, the public sector companies are bogged down by under-recoveries, which are losses incurred due to the selling of petrol, diesel, kerosene and domestic LPG below cost. While oil companies have been free since June 2010 to set the petrol price, decisions on increasing diesel, LPG and kerosene prices are taken after a go-ahead from an empowered group of ministers.
Upstream oil and gas producing companies (ONGC, Oil India, GAIL) are asked by the government to give discounts to the oil marketing companies (OMCs) on the ground that they benefit from an increase in global crude oil prices since their crude is benchmarked to international crude. While downstream refiners-cum-OMCs (Indian Oil Corporation, Bharat Petroleum Corporation Ltd, Hindustan Petroleum Corporation Ltd) bear the first-line impact of the under-recoveries, the net realisations of upstream oil majors are capped because of discounts on crude supplied to the downstream companies.



 
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