Equity managers may look at the weight of the Energy sector in their portfolios as a proxy for the portfolio’s sensitivity to oil prices, or use the over/under weighting of the Energy sector to implement their views on the future direction of those prices. And some may choose to simply avoid sensitivity to oil altogether.
But relying on such approaches may not be enough or, even worse, can sometimes be misleading. Individual companies may hedge their oil prices, for example, or what a portfolio gains in sensitivity to oil stocks it may lose in, say, airlines. A better alternative is to use an Oil Sensitivity macro-economic metric to paint a more comprehensive picture of the impact of oil price movements on a portfolio, as we illustrate in this study.
Let us consider five portfolios that track the STOXX-Japan-600, STOXX-USA-900, STOXX-Global-1800 STOXX-Europe-600, STOXX-Canada-240 indices. The Energy sector’s weight in each of these portfolios varies greatly. In Canada, Energy is one of the dominant sectors (14% weight), while in Japan it has a weight of less than 1%. In the US, Europe and Global portfolios, Energy’s weight ranges between 2% and 4%. We will see that the actual oil sensitivity of these portfolios does not vary as much as the Energy’s weight varies across these portfolios.
To assess the sensitivity to oil, we used Qontigo’s Oil Sensitivity Macroeconomic Factor, which is a measure of an asset’s response to fluctuations in the returns on the West Texas Intermediate (WTI) crude spot price index, a global benchmark for crude oil. We used the standard version of Oil Sensitivity, which is estimated by regressing local asset returns (denominated in local currencies) on changes in the WTI spot price index prices using a 2-year rolling window.
Oil Prices Rally as Demand Soars
Oil prices have seen large swings since the onset of the pandemic. The glut of oil in the spring of last year outweighed efforts by global producers to curb production, at a time when lockdowns prevented billions of people from driving their cars or traveling for work or pleasure, and some factory activities were put on hold, all contributing to a steep decline in demand.
For the first time ever, the price of WTI briefly tumbled into negative territory on 20 April 2020. Even after the coordinated worldwide cut in oil production, the excess supply and plunge in demand resulted in oil-storage facilities filling up, with producers having to pay buyers to take oil off their hands (leading to negative oil prices).
As equity markets started to recover, the price of crude jumped and is now close to highs not seen since before the pandemic, driven by both strengthening global demand and tightening production.
Energy’s weight: Not the best proxy for oil sensitivity
Energy has been one of the worst-performing sectors in 2020. The Energy sector’s 2020 losses had little impact on Japan, USA, and the Global market, in accordance with the small weight of Energy in these markets. Here, the large positive contribution of other factors—such as Market, Style, Country and Currency—neutralized Energy’s negative contribution, and all three of these markets posted gains for 2020.
However, Energy had a large negative impact in Europe (as proportional to Europe’s return), despite its relatively small weight in the benchmark. The STOXX Europe 600 is the only index (among the five we took into consideration) to record a loss for 2020 and the European Energy sector played a large part in it. Energy had a similar level of negative contribution to the European index, as did Specific Return and as did the following factors combined: Style, Market, Country, Currency. The aggregate contribution of the other 10 GICS European sectors in the European benchmark was positive, but not high enough to counter the effects of the other sources of losses, so the STOXX Europe 600 ended 2020 with a negative overall return.
The negative contribution to return of the Energy sector in Canada was larger than the positive contribution of all other Canadian sectors combined, but Canada was still able to post a small gain for 2020 due to the strong positive contribution of Specific Return.
The chart below shows factor-based contributions for each benchmark in 2020. The contributing factors are Specific Return, Sector Contribution (divided into Energy and Other Sectors) and the combination of other Factors, such as Style, Industry and Market for single country benchmarks, plus Country, Currency for multi-country benchmarks.
Yet the fluctuations in oil prices may have had a much higher impact on each of these regions than the sizes of their Energy sectors would otherwise suggest.
Despite the small average weight (up to 4%) of the Energy sector in the US, Europe and Global benchmarks in 2020, each benchmark’s sensitivity to oil was at a similar level to that of Canada, where Energy’s weight was 13%. This suggests that other sectors were also impacted by oil prices, driving home the importance of looking at the sensitivity to highly volatile oil prices separately.
Europe saw the highest 2020 average sensitivity to oil among all benchmark portfolios in this study. The steep decline in oil prices in April caught Europe with the largest sensitivity to oil among these five portfolios, when arguably it mattered most, and therefore Europe incurred significant losses due to the plunge in oil prices in the beginning of the pandemic.
The chart below shows ranges of sensitivity by region between 2012 and 2021, with the horizontal line in the box representing the median and “x” marking the mean. All regions under review saw positive ranges (except for Japan, where oil sensitivity turned negative briefly in 2020). In other words, all of these benchmark portfolios generally move in the same direction as oil prices.
Current low oil sensitivity hasn’t helped as oil prices rallied
Oil sensitivity climbed to more than 20% in each region around the market downturn last year, driven by concerns about the global economy. Nonetheless, these levels were lower than the historical records seen in 2013, when oil sensitivities neared 50%.
Sensitivity to oil prices came down rapidly in the second quarter of 2020, and stabilized at levels well below the long-term median.
That is, these benchmark portfolios—given their large positive sensitivity to oil in early 2020—suffered far more when oil prices tumbled than they now have to gain as prices rise, given their much lower oil sensitivity.
Japan stood out for a short period (between the end of April and beginning of July) when its oil sensitivity turned negative. This meant that the Japanese benchmark was negatively impacted by the increase in oil prices during that period, in contrast to the other four benchmark portfolios. Japan’s oil sensitivity has remained close to zero since July.
The rapid recovery of oil prices will translate into large benefits for portfolios and indices with high positive sensitivity to oil. With similar highly positive levels of sensitivity right now, the Canadian and European markets will gain the most if oil prices continue to rise, despite Europe’s lower Energy weight. Again, this highlights the importance of looking beyond just sector weights.
Investors searching for alternative benchmarks with lower sensitivities to changes in oil prices might want to consider ESG-conscious benchmarks, such as the STOXX Climate Transition Benchmarks (which offer a transition path to a fully compliant benchmark to the Paris Accord) and the STOXX Paris Aligned Benchmarks. As evident in the charts below, both Climate Transition Benchmarks and Paris Aligned Benchmarks have lower oil sensitivities than the standard benchmarks (as expected).
The Energy sector weight in a portfolio may give investors a misleading understanding of how sensitive their portfolio is to oil price moves. As we illustrated in this study, equity portfolios with a small weight in Energy may actually have large sensitivities to oil.  This may be a result of how closely other sectors are tied with oil prices and/or the broader impact of economic recovery.
Given the volatility of oil prices, monitoring oil sensitivity can better inform investors on the prospective impact on their portfolios. Investors having a view on the direction of the price of oil could benefit from tilting their equity portfolios on regions with sensitivities to oil that are most aligned with that view.
And to go beyond just measuring the current sensitivity, investors may want to look into the new Axioma Macroeconomic Projection Equity Factor Model, which allows oil-price sensitivity to be used in the portfolio-construction process, along with directly attributing return to the oil exposure.
For more thoughts and research from the Applied Research team, please click here.
 For the remainder of this study, we will refer to these benchmark portfolios as Japan, USA, Global, Europe and Canada, for short.
 These are GICS Energy sector weights in the STOXX-Canada-240, STOXX-Japan-600, STOXX-USA-900, STOXX-Europe-600, STOXX-Global-1800 indices, respectively, as of February 16, 2021.
 Many thanks to our colleague Walter Wang for providing the Oil Sensitivity data for this analysis.
 For details on the impact of investing in oil on a multi-asset class portfolio, see blog post Oil in a multi-asset portfolio: If you’re looking to reduce risk, look elsewhere…