Energy funds: Can a sooty sector finally throw some heat?

Dan Gillespie, who manages the Rydex Energy Fund, likes his sector - big time.

His fund has more than 90 percent of its portfolio in energy issues, the highest percentage of assets linked to energy among equity funds tracked by Chicago-based information firm Morningstar Inc.

Why not? OPEC energy producers have hammered out a new accord to limit production; oil and gas prices have been low, but are expected to rise; the US economy seems poised to rebound from recession; and world demand should pick up as the US economy climbs.

Such factors give Mr. Gillespie hope that his fund will eventually recover from the 13 percent drop in share value last year.

"I'm cautious in the near term, but for anyone with an investment horizon of six months to three years or longer, this would be a good time to buy into energy," Mr. Gillespie says.

Gillespie, of course, has a clear stake in that viewpoint. But he is not alone in seeing advances for the energy sector.

"A comeback for the Oil Patch?" is how BusinessWeek headlined an analysis of the sector in a generally favorable piece in its year-end, where-to-invest issue Dec. 31.

According to the article, more than a few independent money managers believe energy is the place to be in 2002.

Most energy funds tend to hold traditional oil and natural gas companies, or energy service firms rather than alternative-power firms. They are usually listed as part of the larger "natural resources" category of funds.

Some energy funds are obvious from their names: the Rydex Energy Fund or Vanguard Energy Fund, for example.

But others carry more general-sounding monikers. Example: The State Street Research Global Resources Fund, which tends to favor small natural-gas companies.

The fund had a huge 80 percent gain in 2000, though it ran up against the overall market downdraft last year, and ended down about 3 percent for the year.

Energy funds tend to act independently of the broad-based Standard & Poor's 500 index, says Dan McNeela, who covers them for Morningstar.

Some analysts view the funds - like real estate or even bond funds - as hedges against sharp upward or downward gyrations in the economy.

According to one analysis by Morningstar, only precious metals funds - largely gold funds - deviate more from the S&P 500 index than do energy funds.

Moreover, the funds typically outperform other classes of hedges. Although gold funds have posted solid gains in the past year, over a longer time frame - say, 20 years - energy funds have performed far better because of their link to economic production, unlike gold, Mr. McNeela says.

Most investors probably don't need to be in an energy fund, McNeela adds. If they are in a broad-based fund linked to the S&P 500 index, they already have limited exposure to the sector (about 6 percent).

But investors who monitor their portfolios more closely might profit from an additional energy exposure, he says. McNeela recommends holding an all-purpose energy fund with a low expense ratio, such as the Vanguard Energy Fund.

Limit your energy holdings to about 5 percent of your overall portfolio, he says.

But some analysts are skeptical of the sector overall.

"Energy companies look fairly valued, with little room for upward gains," notes Brian Piskorowski, a vice president and market commentator with investment house Prudential Securities Inc., in New York.

There may be some upward play for oil and natural-gas companies because of the improving US economy, he says. But he believes it will be many months before the advance within the US translates into upward movement abroad.

Bottom line: Energy remains a selective market, Mr. Piskorowski says. He likes, for example, the new Chevron-Texaco merger, which should spell profits for that new firm, as the combined companies undertake cost cutting and start buying back their own stock.

But beyond such unique exceptions, pickings are slim in the overall energy sector, he says.