Most people are now aware of the dramatic environmental consequences of the spill from BP’s oil well in the Gulf of Mexico. What is less appreciated is that much of the UK population ultimately owns BP – with the company making up 6.9% of the FTSE All Share index at the end of March, anyone with a pension fund or a UK equity fund is likely to have some stake in it. Whilst the full ecological, legal and financial impacts of the disaster are still uncertain, the consequences on BP’s share price have already been dramatic. The price plummeted from 655p on 20th April to 430p on 1st June, a fall which wiped £42bn off the company’s market value.
There are several steps investors can take to limit such single stock risks:
Buy funds
Investing in single company shares always carries a risk and it’s not just BP – three years ago the banks were considered safe, dull investments. Though some research suggests holding as few as 15 stocks can provide portfolio diversification, Bestinvest’s portfolios of funds contain several hundred. Dealing costs on such a portfolio would be prohibitive for the private investor, but the economies of scale available from using mutual funds mean all investors can access a multiple stock portfolio at low cost.
Use active fund managers
Index trackers may be cheap but by definition have to invest in accordance with index weightings. FTSE All Share tracker funds thus held around 6.9% in BP at the end of March, whilst active fund managers had the ability to underweight the stock, reducing their exposure. Of our rated funds, M&G Recovery held 4.8% of its portfolio in BP at the end of March and AXA Framlington UK Select Opportunities 3.1%. Richard Plackett had 1.8% of BlackRock UK Special Situations invested in BP, whilst Invesco Perpetual’s Neil Woodford didn’t hold the stock at all.
Invest overseas
The UK stockmarket is already highly international – more than 70% of the revenues of FTSE 100 companies come from overseas. However, it is also highly concentrated, with almost 20% of the index consisting of oil & gas companies, principally BP and Shell – adding overseas equity exposure provides valuable portfolio diversification. Bestinvest’s asset models suggest clients should have 30-60% of their equity exposure outside the UK – the exact amount depends on their attitude to risk. As well as investing in BP, our clients are likely to be exposed to rival oil companies such as Total in their European funds, Exxon in their North American funds and Brazil’s Petrobas in their emerging market funds. One way to get exposure is via a global equity fund such as the 4 star rated Threadneedle Global Select.
Invest in small cap stocks
Our asset models are typically overweight small cap stocks compared to the stock market as a whole. Research suggests that smaller stocks outperform their larger brethren over the long term. The small cap arena also gives skilled fund managers greater scope to outperform than the more heavily researched large companies. Investing across the size spectrum also reduces exposure to the largest stocks such as BP. Our recommendation is the Standard Life UK Smaller Companies fund.
Use environmental funds
Investors could avoid oil companies altogether by investing in environmental funds. Jupiter Ecology, rated 3 stars by Bestinvest, invests in companies involved in clean energy, green transport and waste management, avoiding tobacco, nuclear power and armaments – and the oil majors. Ironically, before joining Jupiter the fund’s manager Charlie Thomas spent three years at BP where his role including advising on environmental policies. Investors should note that even ethical and environmental funds may have exposure to oil companies – their investment policies vary so it is worth checking to see what investments are permitted. Ethical funds with holdings in BP include Marks & Spencer Ethical, Marlborough Ethical and Aberdeen Responsible UK Equity – holders of these funds may not have had oil-soaked pelicans in mind when they invested.
We estimate a typical Bestinvest client would have had 0.6%-1.2% of their portfolio at the end of March invested in BP – sore, but not terminal. Whilst stock risk will always be present in a portfolio, by taking these straightforward measures every investor can ensure they sleep more soundly at night.
If there is anything you wish to discuss please call one of our Investment Professionals on 020 7189 9999.