Topnotch Managers Disagree on Energy's Future
These proven managers stand at the extremes of the energy debate.
These proven managers stand at the extremes of the energy debate.
Even considering the recent summer sell-off, energy stocks have been on a tear in recent years, driven by increasing global demand for energy and soaring oil prices. Mutual funds' exposure to the sector (or lack thereof) has played a key role in determining both relative and absolute performance. But as oil prices have edged lower during recent months and energy stocks have suffered, investors are left to determine whether this is the end of the sector's run or merely a short-term stumble.
No matter which side of this debate you fall upon, you're in good company. Some of the most experienced and acclaimed fund managers disagree about energy's outlook. Let's look at three energy bulls and three energy bears, and their views on the sector. Whomever you agree with, you have good options in which to invest.
Da Bulls
Chuck Bath of Diamond Hill Large Cap (DHLAX)
Diamond Hill Large Cap manager Chuck Bath is an experienced contrarian known for concentrating assets in sectors where he sees the most opportunity. Bath has favored energy stocks since 2004, and the sector's run since then hasn't altered his positioning. The fund's energy stake jumped from nearly 13% in May 2004 to about 22% in December 2004 and still stands near there today. It's the fund's largest sector allocation and above average for a large-value fund. At first, Bath felt low real interest rates, rising commodity prices, and a falling dollar would benefit commodity-related stocks. But because such macroeconomic trends can be fickle, he targets companies with attractive assets in politically stable environments that don't need record high oil prices to grow. That led Bath to Southwestern Energy Company (SWN) in 2004 and the stock has had some extremely strong years since then. Today, Bath holds five energy stocks (his largest position is Devon Energy Corporation (DVN)), all of which look attractive and inexpensive to him based on an assumed oil price that's less than half of the current level.
Bill D'Alonzo of Brandywine Blue (BLUEX)
Brandywine Blue manager Bill D'Alonzo's quick trading style and focus on momentum explains why the fund's energy stake jumped from about 3.5% in September 2007 to nearly 28% in June 2008. It's also why we wouldn't be surprised if that stake dropped just as quickly. That said, D'Alonzo isn't simply chasing hot stocks. He believes elevated oil prices will spur further exploration and production, creating further demand for drillers and equipment and service providers. He also thinks developing countries drive global petroleum demand, and their governments often subsidize fuel for their citizens, insulating them from price increases and keeping demand high. So, D'Alonzo has purchased services companies like Oil States International (OIS), which is helping clients extract oil and gas from Canadian oil sands and the Barnett Shale. The fund's nearly 28% energy stake dwarfs the typical large growth fund's 13% stake, but D'Alonzo is keeping a close eye on his energy holdings as investors have adopted a short-term mindset in the sector, making it vulnerable to sentiment. Still, he feels company-specific factors such as market share gains and technological competitive advantages are driving his energy holdings' growth, which should persist regardless of where oil is headed on a given day.
David Williams of Columbia Value & Restructuring
Manager David Williams' Columbia Value & Restructuring's 36% energy stake is nearly three times that of the typical large-value fund. Williams requires companies to be both "good and cheap," meaning they must have strong market share and able management, among other things, and they must be trading at significant discounts to Williams' estimate of their value. He also seeks companies that are undergoing some type of restructuring, such as cutting costs, moving manufacturing overseas, selling assets, or merging. Williams has been building the fund's energy stake since 2005, and although he hasn't added many new energy holdings over the past two years, he continues to believe the stocks are among the cheapest in the S&P 500 relative to their potential growth. He favors coal stocks for the industry's high barriers to entry. Furthermore, Williams' belief that the sector would consolidate has been on the mark. For example, oil and natural-gas exploration company Devon Energy Corporation (DVN) bought rival Ocean Energy.
Da Bears
Bill Nygren of Oakmark (OAKMX)and Oakmark Select (OAKLX)
Oakmark and Oakmark Select manager Bill Nygren isn't buying into the long-term positive forecasts for energy stocks. Simply put, he believes extreme price spikes among commodities lay the foundation for their own reversal, and therefore doesn't believe current oil prices represent a sustainable, long-term level. Nygren anticipates energy producers and consumers will react to surging oil prices with higher supply and more conservation, which in turn, will lower demand and prices. Nygren has used the market clearing price, which he believes to be well below $50 per barrel, to value energy stocks, which has made most of them too expensive for his taste for a long time. Oakmark Select hasn't owned energy stocks since Burlington Resources was acquired by ConocoPhillips (COP) in 2006. And Oakmark sold ConocoPhillips in the second quarter of 2008 (which now looks to be a well-timed exit point), reducing that fund's energy stake to zero. Not owning much energy has caused both funds' performance to suffer in both absolute and relative terms, but Nygren has had plenty of success diverging from the pack in the past.
Bob Baker, Jason Leder, and Kevin Holt of Van Kampen Comstock (ACSTX)
These managers may not be as high profile as some of the other managers listed in this article, but they've proved their skill over time--and they're thinking about energy in a different and interesting way. They look at energy stocks' price/book ratios because that measure is less susceptible to cyclical commodity prices than earnings-based valuation metrics. And based on book value, the team thinks energy stock valuations simply aren't supported by fundamentals. The fund hasn't owned anything in the sector since early 2007, and although that has hurt relative performance and raised the ire of shareholders, the team has stuck to its guns. The team thinks it will take a major correction in the energy sector for the stocks to appear fairly valued. While the fund has lost nearly 7% during this summer's energy swoon, its performance is better than that of 85% of its large-value peers over the past three months.
Bruce Berkowitz of Fairholme (FAIRX)
Bruce Berkowitz may not seem like an energy bear, as his fund's roughly 12% energy stake barely trails the average large blend fund's 14% weighting. However, the fund's current energy stake represents only about a third of August 2007's 33% stake, illustrating the extent to which Berkowitz has cooled on the sector over the past year. In fact, few were more vocal about the sector being overhyped than Berkowitz at the 2008 Morningstar Investment Conference in June, where he said, "The euphoria over the sector is driving me crazy." Berkowitz has said oil and gas prices are now high enough to increase supply and hurt demand. He sold energy holdings such as Penn West Energy Trust (PWE) and XTO Energy, Inc. between December 2007 and May 2008. The fund had just two energy companies left as of June 30, 2008: Canadian Natural Resources (CNQ) and Ensign Energy Services (ESI), and Berkowitz halved the fund's Canadian Natural Resources position in the second quarter of 2008.
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