Opportunistically Investing in the "Energy Value Chain"

Portfolio Managers Toby Loftin, Trip Rodgers, and Tim Dumois discuss how the Fund’s investment strategy differs from that of other managers, how the portfolio is positioned to take advantage of current opportunities, and why investors should consider active management when investing in the Energy sector.

 

October 2018

  • Toby Loftin
    Toby Loftin
    Portfolio Manager
  • Trip Rodgers
    Trip Rodgers, CFA
    Portfolio Manager
  • Tim Dumois
    Tim Dumois
    Portfolio Manager

Can you please explain the Fund’s investment strategy, and what sets it apart from its competitors?

The Fund invests throughout the entire U.S. energy value chain and offers investors a diversified portfolio of companies, which we believe can deliver above-average capital appreciation over time. Investing along the entire “energy value chain” includes upstream (exploration and production or “E&P” companies and oilfield service providers), midstream (gathering, processing, pipeline transportation, storage, etc.) downstream (refining and marketing), and energy end-user companies. We believe what differentiates our investment strategy from other managers is our flexibility to opportunistically move up and down this energy value chain, and depending on our outlook for each segment, overweight the areas we believe will generate the best returns commensurate with our tolerance for risk.

We think about the energy value chain differently than perhaps other investors do, and we include companies that are significant users of energy, such as industrial and materials companies, in the Fund’s investment universe. In particular, we focus on those end-user companies that can gain a competitive advantage due to low U.S. energy input prices relative to international markets. We believe including end-user companies as part of the energy value chain has the potential to reduce volatility and contribute to performance across full market and energy cycles.

Finally, our intensive, fundamental, “boots-on-the-ground” research process, coupled with proprietary financial modeling, differentiates us from our competitors and allows us to uncover potential equity mispricings that can meaningfully drive performance. Working alongside legendary energy investor and BP Capital founder, T. Boone Pickens, has also helped our portfolio managers to develop a broad network of relationships throughout the energy industry and has facilitated access to management teams and other information sources.

How is the portfolio currently positioned and why?

The Fund is currently weighted heavily toward the upstream sector of the energy value chain, with approximately two-thirds of the portfolio in E&P and oilfield services companies (as of the end of the third quarter). The portfolio is currently aligned to potentially benefit from the following trends:

  1. U.S. Supply Growth. U.S. shale oil production continues to grow, which should benefit domestic-focused E&P and oilfield service companies. U.S. shale producers can ramp up production faster than global offshore producers.
  2. Demand Growth. We believe the current supply/demand outlook for crude oil will support higher oil prices. Global demand for oil continues to grow steadily, driven by consumption growth in the Middle East and Asia, and, importantly, the rapidly growing economies of China and India, where consumption is still a fraction of U.S. consumption on a per person basis.
  3. Geopolitical Events. Against this backdrop of increasing demand, the supply of oil from two major oil producing and exporting countries is declining. Venezuela is suffering ongoing political and economic turmoil that has already cut the country’s oil production in half since 2009. Meanwhile, the announcement of U.S. sanctions against Iran has already caused Iranian oil exports to fall precipitously and exports are expected to continue to decline once sanctions take effect in November.

How have U.S. energy companies evolved over the last few years?

U.S. energy companies have become, in our opinion, much more “investable” over the past several years. We believe these companies are more attractive and better positioned today because of their recent focus on improving the efficiency of their operations, lowering costs to remain profitable during periods of lower commodity prices, and restoring balance sheet strength.
In addition, U.S. energy companies have been adopting more shareholder-friendly practices, such as increasing dividends and buying back stock. In 2018 for example, Anadarko Petroleum and ConocoPhillips each announced a large share repurchase program, and EOG, Cimarex Energy, and Pioneer Natural Resources announced dividend increases.

Why should an investor consider active management when selecting an investment in the energy sector?

Popular energy indexes, such as the S&P Energy Index and Russell 1000 Energy Index, tend to be heavily concentrated in the largest energy companies, as measured by market cap, and distorted by extra-large weightings in two stocks, Exxon Mobil Corp and Chevron Corp. For the Russell 1000 Energy index, for example, the top five holdings account for over 52% of the index, with Exxon Mobil and Chevron alone accounting for 37%. An investor in a passive energy sector fund, therefore, risks not being properly diversified and could potentially miss opportunities to invest in newer, faster-growing companies in an industry which is being transformed by technological advancements.

Diversification does not assure profit nor protect against loss in a declining market.