Equity Versus Fixed Income
Mark Travis, CEO and chief investment officer of Intrepid Capital Management in Jacksonville Beach, Fla., says his firm’s absolute-value investment approach has made it hard to find investments for its managed accounts and mutual funds as the bull market has raged on.
“The only things we’ve found are in the commodities-related space, whether that’s oil and gas, gold and silver, or whatever,” he says. “We try to be conservative when we think about the long-term price for oil, and we’re not assuming oil is going back to $90 a barrel anytime soon.”
Within energy, Travis says his firm focuses on companies with good balance sheets and which sell at a perceived discount to intrinsic value. As of year-end 2014, the Intrepid Small Cap Fund had a 20% weighting in energy. One of the fund’s top energy holdings, Contango Oil & Gas Co., has been taken to the woodshed during the past year and its shares traded at about $23 in early April, or nearly 54% off its 52-week high.
“We think the shares are worth in the high-$30 range, so it’s trading at what we believe is a significant discount,” Travis says. “The question is can we keep our shareholders comfortable long enough to reach that value.”
And with some energy-related holdings, Travis says he prefers fixed-income securities rather than stocks. “It depends on the name, but in some cases we’re comfortable being senior in the capital structure in just the debt,” he says.
Some financial advisors have remained undeterred by hard times in the energy sector. “With the decline that has occurred in energy, I’d think that people would be rebalancing toward energy, and not away from it,” says David Haraway, a financial planner and president of Substantial Financial in Colorado Springs, Colo.
His vehicle of choice is the Energy Select Sector SPDR Fund, a passive, cap-weighted exchange-traded fund that tracks the performance of the energy sector within the S&P 500 index. Portfolio holdings run the gamut from large integrated companies including Exxon and Chevron, services companies such as Schlumberger and pipeline companies such as Kinder Morgan. The fund’s expense ratio is 15 basis points.
“It’s where I suggest investors go for value,” Haraway says. As of early April, the fund was down nearly 25% from its 52-week high.
Cruising Midstream
Regarding oil and gas, an important trend in recent years has been the proliferation of mutual funds and ETFs focused on master limited partnerships, which are publicly traded entities that must get 90% of their revenue from qualified activities including energy and other commodities. Many energy-focused MLPs are centered on oil and gas pipelines and storage facilities––i.e., the midstream part of the production chain. These are stable businesses, and they tend to pay healthy dividends.
The MLP category hasn’t been immune to the travails of the overall energy sector. But the Alerian MLP Index has substantially outperformed the major stock, bond and real estate investment trust indexes since 2006. Not surprisingly, fund managers in this space believe midstream companies are in a sweet spot of the market because they can participate in good times while providing a degree of shelter in bad times thanks to their dividends and the steady need for their services.
Jim Cunnane, co-portfolio manager of the Advisory Research MLP & Energy Income Fund, says the energy infrastructure build-out in the U.S. will continue even in an environment of depressed commodity prices. “There’s been so much energy production that there’s now a glut, but that doesn’t change the fact there’s still a need to transport energy from where it’s produced to where it’s going to be utilized,” he says. “The infrastructure––the midstream guys––are the ones who do that.”
The mutual fund Cunnane co-manages recently had roughly one-quarter of its holdings in high-yield and investment-grade bonds. The high-yield bond sector took a header during the latter part of 2014 on fears that slumping oil prices could lead to debt defaults at energy-related companies, which make up a decent chunk of the junk bond market.
“I share those [debt-related] concerns, and it does to a limited degree apply to the MLPs, but it applies most directly to those MLPs focused on production,” Cunnane says. “The key is the type of assets owned. Those that own commodities highly exposed to price swings and have significant debt levels are challenged, and defaults are on the table if we see an extended period of depressed prices.”
One of the Advisory Research MLP & Energy Income Fund’s largest holdings is a high-yield bond from Spectra Energy, a pipeline company. “We’ve had a preference for its bonds rather than its stock because we felt the stock was on the richer side last summer versus other opportunities that we have,” Cunnane says. “But we think it’s a great company whose bonds will be a stable bedrock to help build a portfolio.”
The fund also owns NRG Yield Inc., one of a new breed of investment vehicles called “yieldcos” that have sprung up during the past couple of years. Yieldcos are created by power companies, such as NRG Energy Inc., as a way to package their renewable or conventional power-generating assets with long-term contracts inside publicly traded entities that pay sizable dividends to shareholders.
“They’re structured as yieldcos rather than MLPs because traditionally wind and solar assets haven’t qualified to be in MLPs,” Cunnane says.
The swoon in oil prices since mid-2014 has caused much angst in the marketplace, but some observers believe the collective angina caused by the supply-and-demand imbalance is overdone.
Kunal Nainani, senior MLP analyst at Eagle Global Advisors LLC in Houston, which runs the Eagle MLP Strategy mutual fund, says from a historical perspective the oversupply situation isn’t as bad as it was in times past. He states the current market is probably oversupplied about one-and-a-half to two million barrels a day, on global demand of about 93 million barrels a day. “So we’re about 1.5% to 2% oversupplied,” he says. “In 1986, we were oversupplied about 20% to 25% of global demand.”
Nainani posits that even as developed nations push for tighter energy standards and technology is creating more energy-efficient cars, factories and homes, the energy needs of the developing world should still provide a runway for energy consumption growth.
“This [global oversupply] has been painful for energy investors, producers, oil service companies and the midstream companies,” he says. “But I think this will prove to be transitory, and I think the recalibration can occur more quickly than the headlines are indicating.”
In other words, the recent throes in the energy sector are most likely just part of the industry’s normal boom-and-bust cycle. If so, the downturn among energy-related names could be a good investment opportunity.