Skip Alternative Energy—Dig for Coal Stocks

Rather than focus on a specific region of the world, global fund managers roam the Earth in search of the best investments. The United States represents less than 40 percent of the world's equity markets, so going global helps U.S. investors avoid home-country bias, says Keith Walter, co-portfolio manager of the Julius Baer Global Equity fund, which has gained an annualized 14 percent over the past three years. Recently, Walter talked with U.S. News about his favorite energy stocks, the changing dynamics of coal, and why he's excited about eastern Europe and Taiwan. Excerpts:

Energy makes up a sizable chunk of your portfolio. What companies in this industry look best?
We're heading toward a world of higher energy prices, so we're trying to invest in the ultimate beneficiaries of this trend. Since more than 80 percent of the world's proven reserves of oil are controlled by governments, it's difficult to invest in stocks that own a lot of the oil in the ground. Our process looks at the world's publicly traded oil companies and compares the valuation of their exploration and production assets as a percentage of those proven reserves, to see which companies own the most oil in the ground at the most attractive price. We also want to make sure that they can get the oil out of the ground at a good profit.

Although this process has led us to some investments in the U.S., the more compelling opportunities in oil companies are in Russia, France, Canada, Norway, and Brazil, among others. One of the best-positioned energy companies today is OAO Lukoil in Russia, which accounts for 19 percent of Russia's oil production and has almost twice the proven reserves of Exxon Mobil but trades at a significant discount in the equity markets. Another global oil company that looks attractive is Total SA, which is based in France. Total has abundant oil reserves and trades at a 30 percent discount to the MSCI World Energy Index. A third name we like is Petrobras, which is based in Brazil. While it's already reserve-rich at 15 billion barrels of oil equivalent, Petrobras has recently made one of the largest new discoveries of oil in more than 20 years.

What about U.S. energy stocks?
Hess Corp. is a U.S. name that is working alongside Petrobras in Brazil on this major new oil find. Hess will likely be able to double their proven reserves of oil from a small $36 million investment they made seven years ago. That said, we think the most exciting part of the U.S. energy sector today is our nation's coal companies. According to the Energy Information Administration, the U.S. has the largest reserves of coal in the world, with a 27 percent share. Compared to other fossil fuels, coal is by far the cheapest fossil fuel in the world today.

Also, the dynamics are changing in the coal industry. Three situations have developed: First, China, which was once a big exporter of coal, has become an importer to feed its growing demand for electricity. Second, there have been major disruptions to the operations of the traditional coal exporters, with flooding in Australia and power outages in South Africa. Third, U.S. coal is more attractively priced than coal from other regions of the world. These dynamics have made for dramatic increases in the exports of U.S. coal, although traditionally, our coal was used primarily for domestic consumption. This export demand shows no signs of letting up in the future, as both India and China each plan to build more than 1,000 new coal-fired electricity plants over the next five years.

How are you investing in coal?
First, we want companies with a lot of coal reserves, and that leads us to Peabody Energy, the largest publicly traded coal company in the world. Peabody has mining operations in the U.S. and Australia, so they'll be able to meet the rising demand from both Asia and eastern Europe for coal. Second, we like companies that are well positioned to take advantage of this new demand for U.S. coal exports, and that brings us to Alpha Natural Resources, which is based in the Appalachian Mountains and is the largest coal exporter via their partial ownership of one of the nation's busiest coal ports in Virginia.

Outside of energy, where are you finding the best investing opportunities?
Another area we are focusing on is agriculture and food stocks. It's clear to us that food inflation is something we are going to be living with for a while, so we are looking at areas where we can take advantage of the supply-demand imbalances up and down the food chain—from fertilizer companies like Potash to food processors like Archer Daniels Midland and Bunge. All of these companies are able to pass on higher prices to their customers as demand continues to increase for their products.

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