Fund Spy

This Fund Brings Stability to a Volatile Sector

Laura Pavlenko Lutton

The following is our latest Fund Analyst Report for Fidelity Select Energy Portfolio  (FSENX). Morningstar Premium Members have access to full analyst reports such as this for more than 1,000 of the largest and best mutual funds. Not a Premium Member? Gain full access to our analyst reports and advanced tools immediately when you try Morningstar Premium free for 14 days. 

Fidelity Advisor Energy retains its Morningstar Analyst Rating of Bronze for bringing stable leadership and a consistent process to a volatile sector.

Manager John Dowd invests in growth. He buys energy sector stocks that offer increasing cash flow per share relative to oil prices to mitigate some risk associated with unexpected swings in commodity prices. Dowd looks for companies with growth drivers such as improving cost controls or technological advantages. For example, Dowd has invested in  Pioneer Natural Resources (PXD), a top holding, for its relative efficiency and scale in extracting shale oil.

This process yields a portfolio of 50-100 stocks, and it includes some industry bets. Half of the funds’ assets were in Exploration and Production stocks as of March 2018, a full 21.5 percentage points past the benchmark, the MSCI US IMI Energy 25/50 Index. Dowd has emphasized this industry since the 2014 oil-price plunge.

Dowd, a career energy investor, has been at the helm since 2006. His approach has become more risk-aware since the fund’s 54% loss in 2008. Dowd subsequently stopped positioning the fund based on macro calls, cut the fund’s sensitivity to oil prices, and limited tracking error to within 5% of the benchmark. Performance subsequently improved, though the fund’s 2008 losses still ding Dowd’s overall track record. From August 2006 through March 2018, the fund returned 1.8% annualized—1.6 percentage points behind the bogy but 2.5 past the average peer in the Energy Equity Morningstar Category. Relative returns since 2009 have been stronger, but absolute returns are volatile, like the sector.

Dowd is backed by seven energy analysts who average seven years at Fidelity and 10 in the industry. The team’s head count has declined from 16 to seven in the years following the 2014 oil crash. That’s concerning, but several recent promotions boost confidence in their ability to retain talent over the long term, as does Dowd’s investment of more than $1 million in his energy funds.

Associate Analyst Jesse Dashefsky contributed to this report.

Process Pillar: Positive | Laura Pavlenko Lutton 05/07/2018
This fund earns a Positive Process rating. Its approach leverages Fidelity’s strength in fundamental analysis and has been applied consistently for the past decade.

Manager John Dowd invests in energy stocks that offer growing cash flow per share relative to oil prices. He looks for firms that grow thanks to cost controls and technological advantages.

Dowd evaluates companies with a fundamental approach. He and his team construct and continuously refine financial models for companies within the energy sector and related industries. They gain additional insight from manager meetings and on-site company visits.

Both halves of the fund’s fundamental approach played into its purchase of  EOG Resources (EOG). Financial models showed EOG to have superior cash flow, while meetings with competitors indicated EOG’s ability to snag top talent. The fund maintained a 6.8% stake in EOG--its second largest holding--through March 2018.

Dowd’s fundamental approach has been in place since he took the helm in 2006. The process hasn’t changed since 2008, when a drastic dip in performance prompted Dowd to rein in bold bets. Dowd subsequently shifted his analytical focus to company fundamentals rather than predicting oil prices. He also limited the fund’s tracking error to within 5% of its benchmark, the MSCI US IMI Energy 25/50 Index.

The fund held 70 stocks as of March 2018, well within its typical range of 50-100 holdings. Nearly all names were in the energy sector or energy-related industries, such as a 1.7% stake in chemical company LyondellBasell Industries (LYB). Most positions are less than 3% of assets. The fund primarily held U.S. stocks (92%), though a bit less than its benchmark (98%), due to modest overweights to Emerging Asia (1.0%) and Canada (4.6%).

The portfolio courts some subindustry risk. Through March 2018, half of the fund’s assets were in E&P players like EOG Resources and Pioneer Natural Resources, leading to a 21.5-percentage-point overweighting versus the MSCI US IMI Energy 25/50 Index. This overweighting reflects Dowd’s view that E&P companies, which are more susceptible to price and political risk than other oil subindustries, will deliver superior growth thanks to their opportunities in U.S. shale.

Dowd had less confidence in the growth prospects of integrated oil and gas giants like  Chevron (CVX) and  Exxon Mobil (XOM). The fund held a 13% stake in this subindustry (23 percentage points under the benchmark) through March 2018.

Performance Pillar: Neutral | Laura Pavlenko Lutton 05/07/2018 
This fund has beaten its peers but not its benchmark since manager John Dowd took the helm in 2006. It earns a Neutral Performance rating.

The fund has outpaced the average competitor in the energy equity Morningstar Category over the short and long term. The fund returned 1.8% annualized from August 2006--John Dowd’s first full month as manager--through March 2018. The average peer lost 0.7% over the same period. More recently, the fund lengthened its lead over the average peer by better-preserving capital in the 2014 oil crash: The fund lost 29.6%, nearly 6.5 percentage points less than the category norm.

The fund has a mixed record versus its benchmark, the MSCI US IMI Energy 25/50 Index. The fund returned 1.8% annualized but missed the bogy by 1.6 percentage points from August 2006 through March 2018. The long-term lag stems from a steep 54% loss in 2008. Dowd subsequently reined in risk-taking, and post-crisis performance improved. For example, the fund recovered faster than the benchmark following the 2014 oil crash. As of March 2018, the fund had higher total and risk-adjusted returns than the benchmark over the trailing one-, three-, and five-year periods.

People Pillar: Positive | Laura Pavlenko Lutton 05/07/2018 
Despite turnover on Fidelity’s energy team, this fund retains adequate resources and steady hands at the helm. It earns a Positive People rating.

Manager John Dowd is a career energy investor. He joined the industry in 1990, Fidelity in 2005, and this fund’s manager roster in 2006. He has testified before Congress on energy issues.

Dowd’s tenure has been marked by a consistent approach, growing risk-awareness, and willingness to learn from setbacks. Case in point: After the fund lost 54% in 2008, Dowd continued to invest in growth but lowered the fund’s tracking error (and thus risk). Performance subsequently improved, including during stress periods like the 2014 oil crash.

Dowd is backed by seven analysts who average seven years at Fidelity and 10 in the industry. The team’s head count declined from 16 to seven in the years following the 2014 oil crash. The turnover bears monitoring: Churn comes with the territory for Fidelity sector funds, and Dowd's team remains comparable in size to those of strong competitors, but it is operating with fewer resources. Confidence in the team's ability to retain talent is also boosted by several recent promotions, including Nathan Strik (now sector lead) and Ashley Fernandes (now a generalist portfolio manager). Dowd invests more than $1 million in his energy funds, which aligns his interests with those of shareholders.

Parent Pillar: Positive | 04/18/2017 
Long one of the industry's biggest asset managers, Fidelity has faced pressure as investors have pulled money from the active U.S. equity funds for which the firm is best known. While significant outflows could gravely impact some firms, Fidelity is shielded by its diverse mix across asset classes (including its own competitively priced index funds), success in other business lines, and private ownership that helps it escape quarterly earnings scrutiny.

The asset-management division remains well-staffed amid cost-cutting across the firm. Still, the firm could stand to rationalize its active-equity fund lineup: There are many redundant or mediocre funds alongside the standouts run by longtime star managers and up-and-comers. Retaining talent remains critical, particularly following the unexpected retirement announcement of a talented young small-cap manager. To its credit, Fidelity has handled equity manager transitions better than in the past. Meanwhile, Fidelity's fixed-income division remains among the industry's best, with a team-oriented approach assuaging key-person risk. Fidelity's target-date funds have improved, and the firm's technology and trading resources remain topnotch.

Even as it has raced to address competitive headwinds by unveiling a handful of factor-based exchange-traded funds, Fidelity remains capable on the actively managed side, earning a Positive Parent rating.

Price Pillar: Positive | Laura Pavlenko Lutton 05/07/2018 
With an expense ratio of 0.79%, this fund’s single share class is cheaper than 85% of no-load funds in the specialty equity Morningstar Category. The fund earns a Positive Price rating.

Laura Pavlenko Lutton does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.