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$4-a-gallon gas may be lifting your fund portfolio

Image: Gas Prices Continue To Rise In California
Samuel Lamb of San Jose fills his truck with gasoline at a Shell gas station in San Francisco, Calif. The pain you're feeling at the pump from $4-a-gallon gas may become a little easier to bear once you receive your next quarterly mutual fund statement.David Paul Morris / Getty Images
/ Source: The Associated Press

Think positive. The pain you're feeling at the pump from $4-a-gallon gas may become a little easier to bear once you receive your next quarterly mutual fund statement.

Chances are your fund portfolio holds big oil names that have been reporting Texas-sized profits this week and boosting dividends paid to their investors. Exxon Mobil, for example, is the biggest component in the Standard & Poor's 500, the most widely tracked benchmark among index funds anchoring many 401(k) plans and retirement accounts.

Exxon earned nearly $11 billion in the first quarter, its biggest profit in more than two years. Exxon and rival Chevron are increasing their quarterly dividends, boosting returns for investors. Combined, Exxon and Chevron make up about 4.6 percent of the S&P 500.

If your portfolio includes a specialized fund that focuses on energy stocks, you've got even more reason to consider the bright side of rising oil prices. Energy stock funds have returned an average 26 percent over the last 12 months, the third-best performance among Morningstar's 21 domestic fund categories. That tops the S&P 500's nearly 17 percent return.

What's more, the top performer among all funds is an energy fund. Integrity Williston Basin/Mid North America Stock (ICPAX) has returned 63 percent, thanks to sizzling gains from the energy exploration and oilfield services companies it favors.

Maintain balance
Such eye-popping numbers make these funds tempting. But be careful if you're considering a specialized fund whose returns are closely tied to swings in energy prices.

"The initial knee-jerk reaction to jump in might not be warranted, because most investors already have plenty of exposure to energy in their portfolios," says Rob Wherry, a Morningstar analyst who tracks energy funds. "It's important to check what you've got in your portfolio first."

Energy stocks account for nearly 15 percent of the holdings in funds tracking the S&P 500, so that's a good threshold for assessing your portfolio's energy exposure.

Yet 15 percent may be too high for some risk-averse investors. It's not just energy stocks that leave an investor exposed to energy price swings. Price changes can also make or break the bottom lines of other companies, including airlines and petrochemical makers.

Also, beware any recently hot area of the market, because strong gains often precede a crash. Witness what happened in 2008. Oil climbed to a record $147 a barrel in the summer, then tumbled below $40 in the winter as economic news worsened and the globe's thirst for oil tailed off. Energy funds lost an average 51 percent that year, compared with the S&P 500's 37 percent loss.

Can these prices last?
As for oil's latest surge, managers of two top energy funds don't expect a repeat of 2008. They're cautious, because it's hard to predict whether the war in Libya and Mideast political instability will continue to generate enough uncertainty over the supply of oil to prop up prices.

But they expect costly oil and expensive gas won't go away anytime soon, based on supply-and-demand fundamentals.

"Oil is finite in quantity, and once you pull a barrel out of the ground, it's gone forever," says Bob Walstad, co-manager of Integrity Williston Basin/Mid North America Stock, the fund that's beaten all others over the past 12 months.

Amid rising oil demand, global production has been stretched for decades, Walstad says: "We've got years of drilling just to catch up."

Walstad co-manages the $319 million fund from Minot, N.D., in the heart of the Williston Basin. The region, stretching across the Dakotas and Montana and into southern Canada, is experiencing a boom in exploration and production of oil extracted from shale deposits. Walstad's fund changed its name and investment mission in 2008 to capitalize on the boom.

Many of his fund's favorite stocks are oilfield services companies: Top holding Baker Hughes is up 52 percent in the past 12 months, and No. 3 holding Lufkin Industries has more than doubled.

Dan Rice, co-manager of BlackRock Energy & Resources (SSGRX), says the strengthening global economy makes him confident that energy stocks will continue delivering strong returns.

"I think I can make 20 to 30 percent returns for a number of years," Rice says of his $2 billion fund, one of two Morningstar analyst picks in the energy stock fund category.

The fund is up 31 percent over the past 12 months. Long-term investors have enjoyed an average 18.4 percent annualized return over 10 years. That places it in the top 4 percent of its category over that time period.

Rice currently favors coal and natural gas stocks, like Massey Energy, a coal miner that's the fund's current top holding. He says recent strong gains for oil stocks have created fewer opportunities to find bargains than among other segments of the energy industry.

Investors have anticipated the that oil prices likely can't remain above $100 a barrel much longer, so that's reflected in the price of big oil stocks. Rice says oil could remain above $100 another six months or so. But he figures prices are likely to return to around $90 over the longer haul, assuming the global economy continues to grow at 2 to 3 percent a year.

Volatility ahead
Still, Rice is optimistic about energy stocks. That's why he's keeping more than 75 percent of his portfolio in small- to mid-sized companies, rather than Exxon or Chevron. Smaller stocks are more likely to post stronger gains in a rising market than bigger ones, and Rice has positioned his fund to capitalize by going small.

However, he acknowledges that approach invites more risk than many investors may be willing to take on. When stocks decline, the smaller names are likely to fall harder than the big ones.

"Because the volatility is so high, it's really not suitable for a lot of people," Rice says. "You've got to have a strong stomach."