Taking speculative risk on energy

Name of company	Shares held	Price	Value £
Afren	364	109.5p	£399
Borders and Southern Petroleum	627	66.50p	£417
Communisis	690	28.75p	£198
Falkland Oil and Gas	6870	81.50p	£5,599
Max Petroleum	880	10.00p	£88
Mediterranean Oil & Gas	8932	4.78p	£427
Petroceltic International	5552	6.25p	£347
Picton Property Income	1188	37.00p	£440
PowerHouse Energy Group	5968	11.00p*	Suspended
San Leon Energy	1936	8.15p	£158
Top Level Domain Holdings	29855	7.77p	£2,319
Xtract Energy	11656	0.395p	£460
Total			£10,852

Source: Investors Chronicle, 18 May 2012. *Last price before suspension

Chris Dillow, Investors Chronicle's economist, says:

You say your attitude to risk is medium-to-high. I suspect, though that many readers would say there’s nothing medium-risk about a portfolio of 12 speculative stocks. They’d be half-right, but half-wrong.

The thing about very speculative shares is that their risks are highly idiosyncratic. For example, the chances of Petroceltic making a big find in Iraq are unrelated to, say, Falkland Oil & Gas's chances of doing well in the south Atlantic. And the thing about idiosyncratic risks are that they can be easily diversified away, leaving you with an overall portfolio which isn’t especially risky. And this seems to be true for you. For example, since the summer Mediterranean has done badly but Falklands has done well – the one has thus diversified losses on the other.

In this sense, your portfolio is not hugely risky. Whether this is a good thing is ambiguous. The good news is that losses on one or two stocks don’t hurt your overall wealth much. The bad news is that nice profits get diluted by losses elsewhere. Paradoxically, it could be therefore that you are not taking sufficient risks.

However, there are a couple of considerations that mitigate this, and caution against having a more concentrated portfolio. There are two risks that are greater for this portfolio than for other investors.

One is distress risk. There is probably more chance of you losing everything in one of these shares than there is for larger, more mature companies, as there's more chance of them getting into horrible trouble. The other is liquidity risk. Bailing out of these companies in an emergency might be tricky, simply because trading in them could become very thin.

What’s more, I fear you might be under-estimating these dangers. You say you’re prepared to take calculated risks after doing your research. This poses the question of how much help research can be for such companies. On the one hand, the possibility that such stocks are neglected by many investors gives you a chance of unearthing a diamond. But on the other, their lack of track record, and the inherent speculative nature of their businesses, diminishes the utility of research. Indeed, it might be positively dangerous. Research gives you an illusion of knowledge and sense of familiarity which emboldens you to take risks without improving your odds of success. Knowledge of the present and past, remember, does not necessarily give us knowledge of the future.

If all this sounds sceptical about the merits of this portfolio, it shouldn’t. There’s one asset you have that allows you to take speculative risk – your youth. The biggest source of your lifetime wealth will not be this portfolio, but rather your work income and savings. These, in effect, mean you can afford to take risks.

Your youth is valuable in another way – it gives you a chance to learn from experience. I’d advise you to make a note of the precise reasons why you’re holding each of these stocks. When you lose money on one or two of them – and this is a when, not an if, so don’t regard losses as personal failings – read those notes and ask: what went wrong? In this way, you can turn losses to your advantage in the sense that they’ll give you useful lessons.

Keith Bowman, equity analyst at Hargreaves Lansdown Stockbrokers says:

At age 32, with time appearing to be on your side in terms of building a capital growth-orientated portfolio, a more measured patient and diversified approach might be worth considering.

You have acquired an investment portfolio of mainly energy-focused 12 companies, worth £10,852 – excluding Powerhouse Energy where trading is currently suspended. Our of your 12 holdings, 10 are worth less than £500. One holding dominates your portfolio (Falkland Oil & Gas), accounting for more than 50 per cent of total value.

Falkland Oil & Gas's share price remains near its 12-month high, with its Loligo well, the first of a contracted two well programme, expected to be spudded in June 2012. At Afren, discoveries for its Nigerian operations continue to underwrite investor sentiment.

However, while your portfolio certainly fits your high-risk attitude, arguably on a text book basis, I have two issues with it. The first is that I would question whether adequate diversification can be achieved by investing £10,000 in individual stocks. A good rule of thumb is that any portfolio worth less than £20,000 should first look towards collective investments, whether they're managed or tracker funds. This provides instant diversification.

We like diverse international generalist funds such as the Jupiter Global Managed or Rathbone Global Opportunities as core long-term building blocks. If you don't want to pay fund manager fees, you could always go for a tracker fund instead.

If you want to concentrate on energy, there are funds for that too. Specialist managed funds such as the Artemis Global Energy or Junior Oils Trust fund might be introduced. The former favours potential growth arenas such as utility companies in the emerging markets. The Junior Oils fund continues to seek value from a focused portfolio of smaller oil companies rather like your own, but with more material positions.

Then we suggest you can complement your established core basket of funds with individual companies of interest, although not forgetting broader strategy principles in pursuing diversity and balance. We would also highlight the importance of using tax wrappers such as individual savings accounts (Isas) in order to shelter your investments from tax. This might not seem so important now, but as your wealth multiplies, it will become so.

Latest trades		Watchlist
Afren	Buy	Petroneft
San Leon Energy	Buy	Northern Petroleum
Xtract Energy	Buy	Red Emperor