Energy stocks boosted by higher oil prices

Outperforming energy stocks could offer protection against negative market movements should tensions in Ukraine escalate, claims Russ Koesterich, BlackRock's global chief investment strategist.

As political destabilisation continues in Ukraine, Koesterich observes that oil prices are rising significantly, with the price of Brent Crude now standing $109.27 a barrel, almost 11% up from its 52-week low of $98.76.

"Fears of escalating violence in eastern Ukraine and potential sanctions against Russia, the world's second-largest oil producer, are pushing prices higher. While equity investors may be ignoring events in Ukraine, oil traders are not, with oil prices hitting a six-week high," he says.

In addition, Koesterich notes that wider energy stocks have outperformed the broader market year-to-date. Since 1 January, the MSCI World Energy index has returned 4.8% compared to a loss of 0.16% from the MSCI World Index.

Political risk

Alongside the benefits derived from their current strong performance, Koesterich says that energy stocks could also offer investors protection against political risk in Eastern Europe, as well as inflation.

"We are advocating an allocation to energy stocks. In addition to being one of the cheaper sectors and a good hedge should inflation start to rise, the sector provides another important feature today: a potential hedge against rising geopolitical risk.

"Should events in Ukraine continue to deteriorate and lead to an escalating series of sanctions and higher oil prices, energy stocks are likely to perform better than the broader market," he says.

Funds heavily exposed to the energy sector include BlackRock's own Global Funds World Energy, Investec Global Energy and Guinness Global Energy, which have returned 3.2%, 3.7% and 7.3% respectively year to date.

Tom Nelson, manager of Investec Global Energy, adds that in current conditions the energy sector could be a "surprisingly defensive place to be" should markets fall.

"Traditionally, if there is a market downturn, energy is the last place you wanted to be. However, because up until February energy had been such an underperformer and because we expect the oil price to be supported both by fundamentals and geo-politics, energy could be a very interesting defensive sector if we get a market pull-back," he says.

Low valuations

Jonathan Waghorn, manager of Guinness Global Energy, adds that on a fundamental level, low valuations should also play a role in future energy outperformance.

"The energy sector has had a terrible 34 months but sentiment is turning positive and we are seeing a nice rebound as money flows back. Valuations are very attractive with the sector trading on a price/earnings ratio (P/E) of 12.5 times versus the S&P 500 on 15.3, so you're talking about a 20% discount. The sector has historically traded on a premium to markets, so there is no reason why that shouldn't close," he said.

Year to date, Waghorn's fund has strongly outperformed both the MSCI World Energy index and its sector, IMA Global, which has lost -0.3% over the same period. This compares to a return of 1.10% over three years.

Both BlackRock and Investec have both strongly outperformed their sector, IMA Specialist, which has returned 0.25% year to date, however are both slightly lagging the MSCI World Energy index.