For decades, the 60/40 portfolio has been one of the most familiar approaches to investing: Roughly 60% in stocks for growth and 40% in bonds for income and stability.
There’s a reason that framework has lasted. Stocks and bonds remain important building blocks for many investors.
But today, investors have more choices than they did a generation ago.
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High-net-worth investors, family offices and advisers increasingly have access to private credit, real estate, private equity, infrastructure and direct energy investments that can provide exposure to assets and economic drivers outside the traditional public markets.
That doesn’t mean the 60/40 portfolio has stopped working.
It means investors now have the opportunity to ask a broader question: What other assets may complement it?
Diversification: What drives the investment?
Owning multiple funds doesn’t always mean a portfolio is truly diversified.
Stocks and bonds can respond to many of the same forces, including interest rates, inflation, economic expectations and broader market sentiment. In 2022, for example, investors were reminded that stocks and bonds can decline at the same time.
That’s why I believe diversification should be viewed not simply in terms of how many investments someone owns, but in terms of what actually drives their value.
Alternative investments can introduce different sources of potential return.
Real estate may be driven by rents and property values. Private credit may be driven by contractual interest payments. Infrastructure may benefit from long-term demand for essential services.
Direct oil and gas investments can be tied to something different again: The development, production and sale of energy.
Where direct oil and gas can fit
I’ve spent most of my career in oil and gas, and one of the things I believe investors should understand is how different direct energy ownership can be from simply purchasing shares of a publicly traded energy company.
A public oil and gas stock is still a stock. Its price can be influenced by the broader market, investor sentiment, analyst expectations, interest rates and company-specific events.
A direct oil and gas investment can provide exposure much closer to the underlying assets themselves.
Depending on the structure, investor capital may be used to acquire acreage, drill and complete wells, bring production online and develop reserves.
That distinction matters.
When an operator deploys capital into drilling, the goal is to turn dollars invested today into producing energy assets tomorrow.
A successful well can potentially create several layers of value, including current or future oil and natural gas production, potential monthly cash flow, additional proved or undeveloped reserves, potential value from continued development and potential value if producing assets are ultimately sold or otherwise monetized.
That’s one reason I believe direct energy deserves a place in the broader diversification conversation.
Instead of investing solely in financial instruments, investors can potentially participate in the development of tangible assets producing commodities the global economy uses every day.
Capital goes to work in the ground
This is an important distinction in the way I think about oil and gas investing.
When we raise capital for a drilling program, the objective is not simply to hold acreage and hope it appreciates.
The capital has a job. It can be deployed to drill wells, complete wells and move assets from undeveloped potential toward production. Each stage can potentially add information and value to the asset.
Before a well is drilled, much of its value may be based on geology, engineering and nearby production. Once it is drilled and completed, the operator has additional data. Once it begins producing, there is another layer of information: Actual production performance.
That production history can help engineers evaluate reserves and can give lenders, potential buyers and other market participants more information with which to assess the asset. In other words, drilling can be a value-creation process, not simply an expense.
That’s the model I find particularly compelling: Putting capital to work with the objective of creating producing assets and building value through development.
Energy demand isn’t theoretical
There’s also a fundamental reason oil and gas remains relevant. The world continues to require enormous amounts of energy.
Transportation, manufacturing, agriculture, petrochemicals, electricity generation, data centers and countless parts of the modern economy depend on reliable energy supplies.
At the same time, oil and gas production is naturally depleting. Existing wells decline, which means new capital and new drilling are continually required simply to replace lost production. That creates an interesting dynamic for investors.
Energy is both an essential commodity and a capital-intensive business. The industry needs investment to find, develop and produce the resources the economy continues to consume.
For investors who understand the risks and have the appropriate time horizon, participating directly in that development can provide exposure to a very different part of the economy than a traditional stock-and-bond portfolio.
The tax treatment can be meaningful
Direct oil and gas can also offer potential tax characteristics that are different from many traditional investments.
Depending on the structure of the investment and an investor’s individual tax circumstances, certain drilling and development expenses may qualify for deductions, including potential intangible drilling cost deductions.
Producing oil and gas properties may also qualify for depletion deductions over time. For certain high-income investors, these potential tax benefits can materially affect the overall economics of an investment.
I don’t believe anyone should make an investment solely for a tax deduction. The underlying assets, operator, development plan and economics must make sense first.
But when a fundamentally attractive investment also offers potential tax advantages, those benefits can become an important part of the overall investment consideration.
Because the rules can be complex and investor circumstances vary, individuals should always consult their own tax professionals regarding how those provisions may apply.
Start with the asset
When evaluating an oil and gas opportunity, I’ve always preferred to start with the asset rather than the spreadsheet.
Projections matter, but they’re only as good as the assumptions behind them.
I want to know what exists in the ground and what we know about the surrounding area. I ask if there is existing production, if nearby wells have successfully produced from the same formations, what the geology tells us, what the development plan looks like, and what the capital will be used for. I also want to know how experienced the operator is at drilling, producing and selling oil and gas.
These types of questions tell me far more than an attractive projected return by itself.
In our business, the objective is to acquire and develop assets where we believe operational execution can create additional value.
That means deploying capital into drilling and development, gathering real production data, building reserves and continually evaluating the best way to maximize the value of those assets.
The operator matters
Oil and gas isn’t a passive business from the operator’s perspective. Execution, drilling decisions, completion design, cost control, land and title work, production operations, commodity marketing and timing: These all matter.
That’s why I believe investors evaluating direct energy should spend as much time evaluating the operator as they do evaluating the projected economics.
An experienced operator should be able to explain where investor capital is going, what milestones are expected, what can create additional value and how the assets may ultimately be monetized.
The investment isn’t just in a commodity. It’s also an investment in the operator’s ability to execute a development strategy.
Private investments require patient capital
Direct oil and gas investments are generally private investments, which means they should be viewed differently from publicly traded securities.
An investor may not be able to sell an interest with the click of a button. Timing and patience are important.
Patient capital can allow an operator to execute a multi-stage development strategy: Acquire the asset, drill wells, establish production, build reserves and pursue opportunities to create additional value over time.
For investors who have sufficient liquidity elsewhere in their portfolios, that longer-term approach may fit well alongside more liquid public-market investments.
Is 60/40 enough?
For many investors, it may be.
There’s nothing inherently wrong with keeping a portfolio simple.
But for investors with significant assets, longer investment horizons and the ability to accept the risks and illiquidity associated with private investments, alternatives can broaden the opportunity set.
I don’t view direct oil and gas as a replacement for stocks or bonds. I view it as something fundamentally different. Stocks provide ownership in companies. Bonds provide contractual debt exposure.
Direct oil and gas can provide qualified investors with the opportunity to participate in the acquisition, drilling, development and production of real energy assets.
That is an important distinction.
The question shouldn’t be whether every investor needs alternatives.
The better question is whether adding assets driven by different fundamentals can make sense within the investor’s overall strategy.
For the right investor, I believe direct energy deserves to be part of that conversation. At the end of the day, diversification isn’t about making a portfolio more complicated.
It’s about putting capital into assets that have a clear purpose, a clear economic rationale and the potential to create value in different ways.
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This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.
