EM Energy:  Regime Shift

Energy is a lightly held sector, a bit part player in a world dominated by Tech, Financials and the EM Consumer. The average holding weight among the active EM funds in our analysis stands at just 3.81%, underweight the benchmark by -2.11% on average.

The fact that nearly a quarter of active EM managers have no exposure to the Energy sector is perhaps the most telling statistic of just how under-owned the sector is. Part of that reason, we believe, lies in the risk of not holding Energy when index weights are so low.

With Oil prices at multi-year highs, the Energy sector has started to outperform in a big way, with EM Energy outperforming the broader MSCI EM index by over 30% over the last 12 months. With just 22.7% of funds overweight the benchmark, active EM managers are feeling the pinch. The risk of being underweight or avoiding the sector completely has moved significantly higher.

One of the factors that has driven Energy to the margins of EM investment is the rise of secular growth opportunities in Technology, Consumer Discretionary and Communication Services. Indeed, the current investor base in Energy is heavily skewed towards the Value and Yield end of the spectrum. Instead, Aggressive Growth managers have rotated towards the secular growth opportunities within Packaged Software, Internet Retail, Biotechnology and Internet Software/Services.

Can the lure of a cyclical growth opportunity such as Energy be enough to win back investment from Growth investors? If Energy keeps outperforming it will undoubtedly push Growth investors to look for opportunities within the sector. We identify 2 stocks that already have an investor base among both Aggressive Growth and Growth funds, whilst also appealing to Value investors. As such, we would expect both to be on the shortlist of the many underweights and non-investors looking to ramp up allocations in the Energy sector as we shift to a new ownership regime.

Analysis taken from our EM research, covering 247 active GEM funds with combined AUM of $500bn