The global demand for oil is not as low as most investors think and the asset class has been mistakenly tarred with the same brush as the mining sector, according to Jamie Ross.
The manager, who heads up the £388m Henderson UK Alpha fund, knocked their largest holding HSBC off of the top spot last month in favour of oil giant Shell, which hadn’t previously featured in the fund’s list of top 10 holdings.
Investors are well-versed in the headwinds surrounding the oil & gas sector at the moment, which have been sparked by plummeting prices over the last two years as a result of global oversupply.
Performance of index since 2015
Source: FE Analytics
Ross (pictured), however, says that these fears have been blown out of proportion and that now is a good time to buy into the sector while valuations are cheap, despite emphasising that the fund doesn’t necessarily have a value bias and adopts a blended approach to stock-picking. 
“We’re more constructive on oil because we see the global demand environment as okay and would expect demand to grow slightly this year, but at the same time we’ve seen OPEC led by Saudi Arabia trying to pump as much oil as they possibly can and that’s had a dramatic impact on the oil price, but there’s not too much more they can do now,” he explained.
“Even if they really wanted to, they’re running at pretty high capacity utilisation rates so there’s not more they can pump.”
The manager says that oil & gas stocks are often banded together with mining companies under the ‘commodities’ umbrella, but argues that miners have far greater headwinds on the horizon over the long term compared to oil.
Ross, alongside co-manager Neil Hermon, took over the helm of Henderson UK Alpha three years ago following its bottom-decile performance under the management of Stephen Peak.
Over their tenure though, the fund has achieved an above-average performance compared to its sector average and its benchmark, and is in the top quartile over one and three years.
Performance of fund vs sector and benchmark under Ross
Source: FE Analytics
Part of the rebalancing that the managers implemented involved cutting out all mining stocks, which is a move that Ross says has stood the fund in good stead given China’s growth slowdown.
According to data from the World Bank, the World Steel Association and Goldman Sachs Global Investment, a vast proportion of iron ore demand comes from China, a trend which has reared its head since the turn of the millennium.
In comparison, data from Nomura shows that China’s oil consumption is minimal and suggests that the sector is far less dependent on the economic strength of just one region.
Global oil consumption and iron ore demand
Source: the World Bank, the World Steel Association, Goldman Sachs Investment, Nomura
“For us, looking at the mining space and the energy space has presented a number of interesting things to think about, talk about and analyse,” Ross said.
“The two obvious conclusions to draw from this data are that: one - global demand for iron ore has been roughly flat for the last 40 years or so and two - since 2000 you’ve seen China come from nothing to well over half of the market.”
“Over the same time period for oil you can see that China is much less important. Our view is that, with what’s going on in China at the moment, it’s very hard for a UK fund manager to sit here and express any eloquent views about what’s actually going on because the data we see is often not the reality and it’s quite difficult to make a view.”
“But looking at hard facts like this I think it’s fairly easy to say that China has been through a period of rapid over-industrialisation and that is likely to unwind.”
The manager points out that this doesn’t necessarily mean he expects China’s growth to continue slowing, but he believes that the region’s demand for iron ore will decrease over time, which will have a far greater impact on mining than it will on oil and gas.
Another he has increased his exposure to oil is because he says the US shale industry is in the throes of being “crushed”.
“We’re not yet noticing this in production volumes - which have held up very strongly - but we are noticing it in the rig count which has fallen off dramatically. That has very important ramifications for oil production over the next two years,” he continued.
“Our belief is that the market will come back into some sort of balance, it’s difficult to tell whether it’s going to be this year or next and anyone’s guess is as good as mine, but when the market does the oil price is likely to be higher rather than lower.”
The reason that Ross has significantly increased his weighting in Shell specifically is that, unlike fellow oil giant BP following the Macondo tragedy, it has had no need to cut its capital expenditure and so it has more scope to do so going forwards.
He adds that the firm has also been investing quite aggressively over the last few years while other oil and gas companies haven’t – it acquired BG Group earlier this year, for instance. He says that this means investors will get a decent cash-flow growth from the stock even if the oil price remains flat.
“Shell’s ability to cut capex is good, its balance sheet is fine for the moment, and for that reason we expect it to be able to persuade investors over the next 12 months that that its dividend is sustainable. This should hopefully be helped by a bit of a supportive environment for oil.”
Henderson UK Alpha has a clean ongoing charges figure of 0.83 per cent and yields 2.1 per cent.
