Ofgem called for an investigation by the Competition and Markets Authority into the competitiveness of the energy market between the six largest energy providers, SSE, Centrica, RWE Npower, Scottish Power, E.On and EDF Energy, who control over 95 per cent of the UK’s retail market. Spear says that the sector is popular with equity income portfolios for their steady dividends and political interference in the sector could hurt those funds.
“Traditionally energy firms are bought as an income stock because of their dividend flow but it will be there that this investigation is likely to take a hit, this could be another difficulty for equity income managers,” he said.
“However, there’s always a knee-jerk reaction in these scenarios that causes share prices to fall and they creep back up again and there’s no reason to suggest they won’t this time.”
“It could turn out to be a great buying opportunity. It’s what Neil Woodford did with tobacco stocks.”
“His argument was that whenever there was a policy review on tobacco, the share price would drop and he would buy more and the share price would rise again.”
“It is almost that same scenario with energy companies. Fund managers are going to have opportunities throughout the 18 month expected duration of the investigation to buy the energy companies’ stocks at low prices and see the price bounce back.”
“We all need energy, and that’s not going to change.”
In the IMA universe 26 funds hold Centrica as one of their top 10 holdings including Fidelity Enhanced Income, Newton Higher Income and Aberdeen Responsible Equity Income.
SSE is held by 20 funds in their top 10 holdings including Newton Global Higher Income, Premier Optimal Income and Marlborough Multi Cap Income.
Spear says investors could potentially profit from an expected 18 month investigation by investing in an active fund whose manager can time the market and capitalise on share price dips, which he thinks will eventually recover over time.
Spear advises investors to go to an active fund manager rather than investor in energy shares themselves.
“With individual investing the problem is always timing. You need to be on the ball all the time and that’s where the fund manager comes in.”
The news hasn’t immediately hit energy stocks significantly, with Centrica’s share rising despite the news.
Centrica and SSE have both performed well over three years although both have took a nosedive in October 2013. SSE’s share price has since recovered whereas Centrica continues on a downward trajectory.
Performance of stocks over 3yrs
Source: FE Analytics
This was when Labour leader Ed Miliband first floated the idea of price freezes in the industry, which star manager Neil Woodford described as “insane”.
Spear recommends Standard Life UK Equity Unconstrained, managed by Ed Leggett, for investors looking for an active fund but also advises caution for short term investors.
“They would be an obvious choice but it’s not a fund for the faint of heart, it’s only for the medium to long term investor though.”
“ My experience of Standard Life is they doing very well in a rising market but they do less well in a falling market and investor must make their own macro decision as to whether markets look good for, say, the next 12 months.”
I think they do, but with lots of volatility along the way.”
The £1.1bn fund is a top quartile performer of 1, 3 and five years. It has returned 64.88 per cent to investors over three years, beating its sector and benchmark which rose 36.02 per cent and 29.04 per cent, respectively.
Performance of fund vs sector and benchmark over 3yrs
Source: FE Analytics
SSE announced yesterday that they would freeze energy prices until 2016, which it said could hit profits.
Ofgem called for an investigation in a report where it claimed competition in the energy market was ineffective.
It subsequently referred the market to the new competition body, the Competition and Markets Authority and all six energy companies said they welcomed the referral.
Tim Yeo, chairman of the energy Select Committee said a breakup of the companies was the most likely conclusion of the investigation as this was the quickest way to restore consumer confidence.
However, Charles Hepworth, investment director of GAM says the announcement of the investigation does not worry him and he expects a muted response from markets.
“The review is obviously more of a political one and as normally in politics this comes after the trend has turned, the rising energy prices are now peaking and in some cases are falling.”
“Any outcome won’t likely be for another few years hence the tepid market reaction to the news, Centrica is up on the day.”
“So in the interim I wouldn’t expect the UK energy stocks to do anything more than the typical defensive yield characteristics they offer.”
“That area is not something we are hugely playing, focussing instead on typical cyclical growth stories that are biased to a recovering global economy and not utilities per se.”
