As the world economy gains strength, energy investments have been getting a new look from pension funds as a way to diversify portfolios and enhance overall returns.
Paying particular attention to the asset class are public funds, which weren't major players during the first round of pension fund investments in the 1980s.
In addition, Wall Street, which has never been a major backer of alternative investment classes, has taken notice of commodities as a potential pension fund investment. Goldman, Sachs & Co., New York, recently recommended that large private pension funds carry a 5% commodities allocation, including oil and gas.
The number of oil and gas investment managers has held relatively constant during the past five years, although at least one high-profile firm is gone. American Exploration Co., Houston, withdrew from the institutional fund-raising market to focus on its primary exploration business.
And, some energy investment managers appear to be picking up steam.
First Reserve Corp., a Greenwich, Conn., investment firm specializing in equity participation in growing, energy-related companies, and Torch Energy Advisors Inc., a Houston-based direct oil and gas investment firm that acquires proven producing properties, have had major fund closings in the past 2 years.
First Reserve closed its most recent fund in 1992 with $185 million in total commitments from existing clients such as Eastman Kodak Co., Delta Air Lines Inc. and Southern New England Telephone Co., and new commitments from the California Public Employees' Retirement System, California State Teachers' Retirement System, Virginia Retirement System, Orange County (Calif.) Employees' Retirement System and San Francisco City & County Employees' Retirement System.
John Hill, First Reserve chairman, said a seventh fund will be formed in next May with a $250 million goal.
Mr. Hill said pension funds look to energy investments as an inflation hedge and for an opportunity to earn annual returns of up to 15% or more.
"We think the toughest period of raising money has been the last 10 years, when oil prices were coming down and we were competing with stocks and bonds. Now some pension funds are finding the only way to meet their return objectives is to consider investments in something other than stocks and bonds - such as energy, venture capital or global investments."
Public pension funds, he said, "didn't do any energy investing in the 1980s. But they were being called on (by energy investment marketers) and were getting an education." He said large public pension funds were looking for ways to diversify their portfolios after fulfilling their allocations to real estate and other alternatives while seeking new asset classes for private investments.
"Public pension funds came in at the right time; they missed the early 1980s (when the oil and gas market crashed), and the '90s should be dynamite," said Mr. Hill.
Jim Timmons, executive vice president at Torch, echoed Mr. Hill's sentiments: "Public funds are looking at all of the alternative investment classes. The general feeling is that they won't see the type of returns they had in traditional financial markets during the 1980s and early '90s. Now non-traditional investments offer higher returns without too much additional risk exposure.
"Public funds are much more active in alternative investment classes now; these institutions are looking at alternatives with the expectation that traditional investment markets won't have the returns they have had in the past," he said.
Torch closed its eighth fund in the summer of 1993 with commitments of $105 million. Torch officials declined to name the investors, but said there was major participation from the public pension fund sector. Officials at the Colorado Fire and Police Pension Association, Englewood, confirmed the fund's participation but declined to discuss specifics.
Torch recently commissioned a study by Ibbotson Associates Inc., Chicago, that found direct energy investments can decrease the risk of many portfolios because the returns move in opposite direction to returns of other commonly held assets such as domestic stocks, bonds and international stocks.
The study also showed direct energy performs well during times when inflation is high or rising, and provides the same diversification benefits to portfolios as international stocks.
Rod Mitchell is president of The Mitchell Group, a Houston investment management firm specializing in energy industry equities. He said his portfolios have averaged a 19.6% annual return from Dec. 31, 1991 to Sept. 30, vs. 6.9% average annual return for the Standard & Poor's 500 Stock Index. And, he predicted the sector should do even better as energy prices climb in coming years.
"We are in a very tight oil market. There is currently no shortage ... but right now excess capacity compared to world demand is the lowest it has been in a generation. The excess supply in 1986, for example, was near 30%. Today the excess is probably below 5% and it could be even tighter," said Mr. Mitchell.
Mitchell Group clients include Williams Cos., Vought Aircraft Co. and the Houston Firemen's Relief and Retirement Fund.
Two other long-time energy investors - TCW Group Inc., Los Angeles, and UBS Asset Management (formerly Chase Investors Management Co.), New York, both of which have been in the market continuously since the early 1980s - are still raising energy investment funds. Much of the money comes from existing clients.
Victor Romley, managing director at UBS, said his firm has about $850 million under management in separate account portfolios. UBS purchases royalties on producing properties, finances drilling programs and acquires working interests in producing properties.
TCW closed a $600 million fund last summer, and has about $1.8 billion under management in oil and gas. Art Carlson, TCW managing director, said TCW does primarily mezzanine lending to independent and major oil and gas companies with maturities of seven to 10 years.
TCW clients include Atlantic Richfield Co. Inc., E-Systems Inc., and Rockwell International Corp. UBS clients include General Motors Corp. and AT&T Corp.
Despite the activity, Gene Graham, a Houston oil and gas consultant, warned the oil patch is not a gold mine for institutions.
"There is still a large pool of money waiting to make acquisitions and which isn't (invested). Right now there is a lot of money chasing too few quality acquisitions, and people are being picky about what they are buying," she said.
She said energy investments are appropriate for some pension funds, but warned "it is a cyclical business and there are good opportunities to be found throughout the cycle. But you have to be there all the time. It is hard to pick the right time to get in."