Energy Funds Shrug Off Talk of a Bubble - TheStreet

Soaring oil prices are turning energy funds into the tech funds of the early 21st century. But will they end up suffering the same unpleasant fate?

Not too long ago, investors bent on chasing the fashionable tech trend dumped cash into funds filled with highfliers like

Microsoft

(MSFT) - Get Report

,

Cisco Systems

(CSCO) - Get Report

and

Sun Microsystems

(SUNW) - Get Report

. Tech fund returns soared in response to this tidal wave of hot money, a wave many investors thought they could surf forever. That is, of course, until it all came crashing down.

Less than a decade later, momentum investors are paying the same type of attention to energy funds. According to fund tracker Lipper, energy funds saw inflows of $160 million in 2001. In 2004, that number jumped to $4.65 billion. And 2005 is rocketing even higher, with $2.5 billion in new money in just the first two months of the year alone.

At the end of February, energy funds held record assets of $23.3 billion. While that may seem like chump change compared to the assets held in tech funds during the bubble -- tech funds hit $119 billion in December 1999 -- the rate of inflows into energy funds has reached a level on par with that of the late-1990s madness. Flows into energy funds in February 2005 were up 11.4%, says Lipper, more than the 11.2% move into tech funds in December 1999, the highest percentage jump during the bubble.

In terms of performance, the average energy fund is up nearly 14% year to date, according to Morningstar, easily making it the top-performing fund category. Energy funds are up 39% over the past year, outpacing even oil's rise from the mid-$30s for a barrel last year to recent levels in the mid-$50s.

Energy funds may be retracing the initial trajectory of tech funds in the late 1990s, but Don Cassidy, senior research analyst at Lipper, says there is a notable difference between the tech and energy stories, which should keep investors from experiencing the same painful lessons they learned last decade.

"Unlike the majority of tech companies back then, the story for energy is real," says Cassidy. "Companies like

ExxonMobil

(XOM) - Get Report

and

ConocoPhillips

(COP) - Get Report

have earnings and pay dividends."

Cassidy believes the energy rally still has room to run, provided global economic growth continues at a steady clip. He suggests investors try not to chase the rally and instead cautiously buy on the dips, keeping in mind that these funds are indeed "up at historic levels."

Economic growth, especially in fast-growing China, is the linchpin to nearly all the bullish arguments when it comes to oil and, in turn, energy stocks. Says Michael Sedoy, energy and utility analyst at Salomon Brothers Asset Management, "Energy is a bet on the economy, and only a global economic recession will knock it down."

Nearly insatiable Chinese demand has been a major stimulant to oil prices, and Sedoy isn't expecting a slowdown in the near future. One factor? China's vanity over hosting the 2008 Olympic games. "The Chinese don't have time to have a recession before the 2008 Olympic games," Sedoy says.

On the supply side of the equation, oil producers have struggled to keep up with growing worldwide demand. Sedoy attributes much of 2004's jump in oil prices to a lack of spare capacity among the OPEC nations. Sedoy points out that inventories were perilously low throughout last year and have only recently recovered ahead of the summer driving season.

With capacity at a premium, Sedoy suggests investors look for funds heavy with drillers like

Transocean

(RIG) - Get Report

and oil infrastructure names like Dutch pipeline producer

Chicago Bridge & Iron

(CBI)

.

"There are very few rigs available and they are expensive to build," says Sedoy, who also likes Canadian oil sands companies like

EnCana

(ECA) - Get Report

now that the price of oil is high enough to make it worth their while to produce it.

Rumor also has it that a new force has been weighing on the markets: hedge fund speculation. The thousands of hedge funds that have popped up over the course of the past few years are supposedly bidding up the price of oil and -- so the whispers say -- will eventually take it down just as quickly.

The buzz that speculators were controlling the price of oil grew so loud that when the price of oil blew past $56 a barrel last week, the government stepped in to say that hedge funds were not to blame for rising crude costs.

"The lack of both spare capacity and inventory cushions to cover potential surges in demand or disruptions in supply, in a strong demand environment, is the primary force behind currently high prices," said the Energy Information Administration, which is the Energy Department's analytical arm. "As such, the EIA does not believe that hedge funds and speculator trading in energy are the main reasons why oil prices are higher now than they were a year or two ago."

Mutual fund investors may not need to fret about speculative traders slamming down the price of oil on a whim and taking energy stocks with it. Unlike the shooting star funds of the tech bubble, energy fund investors can rest assured that their fund's appreciation is based at least in part on real assets.

Nevertheless, investors considering energy funds at this stage might want to take note of the rising number of funds closing to new investors -- if only as a contrarian indicator that a top, or even just a bump in the road, may be nearby.

Vanguard, for example, closed its $6.2 billion

(VGENX) - Get Report

Vanguard Energy fund in December 2004 to deter hot money from entering it. And the $1 billion

(SGLSX) - Get Report

BlackRock Global Resources fund closed on Jan. 31 because it was getting too big.

"Like the tech run-up, the energy sector has seen a lot of investor interest, and investors have a bad track record of piling in right at the top," says Sonya Harris, energy fund analyst at Morningstar.

Editor's Note: Click here to see a video presentation by Gregg Greenberg on energy funds.