It’s certainly been a tough few years for the energy sector since the oil plummet of 2014-15, but crude prices have been recovering lately, as have the returns from energy equity funds. While their cumulative 10-year average annual compound return through the end of May 2018 was a disheartening -3.3% and the 12-month return was only 5.8%, the 3-month return was a hefty 14.1%.
While a three-month gain certainly does not constitute a trend, Hoa Hong, co-manager (with Curtis Gillis) of the Signature Global Energy Fund, which posted a 12.9% return for the year ending May 31, believes the tide has finally turned, at least for oil producers. “We are constructive on oil,” she says. “Supply and demand is fairly balanced now, and the excess reserves that had built up have been drawn down.”
She noted that at the meeting of the Organization of the Petroleum Exporting Countries (Opec) on June 22, production would likely be increased, which the Opec ministers in fact agreed to do, and that this action could result in moderated prices over the short term. But she added that the energy sector has been underinvested since 2014, particularly in the case of international companies, so the effect may not be deep or prolonged. “Production capacity is down to record low levels,” she notes.
As for natural gas, Hoa is less optimistic. “We’re generally more bearish on gas,” she says, citing among other causes the fact that so much gas is being produced as a byproduct of oil drilling. “The associated gas from oil production is helping to depress costs, and over the next 12 to 18 months, some 45 billion cubic feet (bcf) will be starting to come on stream in the U.S.,” she says.
In any event, Hoa and Curtis say they continue to invest as they have done since the fund was established in 1998. “Curtis and I have been covering the market for the past 30 years and have been through a few cycles, so we’ve acquired a deep understanding of the sector as well as the companies,” says Hoa.
“We’re style-agnostic, and we look at both macro and micro factors,” Hoa adds. “We look at the fundamentals of supply and demand, and we study the companies deeply. We try to understand the management team, we look at the balance sheet, especially the amount of liquidity, and we come up with an internal valuation. If it’s undervalued, we still have to be sure we’ll be well compensated for the risk we would be taking by investing.”
While the fund is global in scope, this strategy has led to a portfolio that, at least for now, consists primarily of U.S. and Canadian equities (at 43% and 40% of total assets respectively). There are 40 names in all, with allocations varying from a percentage point up to 5.9% for Houston, Texas-based EOG Resources Inc., the fund’s current top holding. “We’ll make some pretty big bets if we feel it’s warranted,” says Hoa.
One new name in the binder is Concho Resources Inc. of Midland, Texas, which recently purchased RSP Permian, increasing the company’s exposure to the namesake Permian Basin, a prolific oil and gas production area in Texas and New Mexico. “Permian production was trading at a discount to Brent [a benchmark crude oil blend] because infrastructure there has not kept pace with production, but those infrastructure issues are being dealt with, so we have increased our exposure there,” says Hoa.
Courtesy Fundata Canada Inc. © 2018. Olev Edur is an experienced financial and business journalist and a frequent contributor to the Fund Library.Investments mentioned are not guaranteed and carry risk of loss.