FPA Capital’s Bryan Beats Peers Embracing Oil Volatility: Riskless Return
Dennis Bryan, whose FPA Capital Fund (FPPTX) beat 99 percent of peers over the past quarter century, is betting oil stocks will keep him ahead of the competition as growing energy demand rewards investors who are prepared to sit out some of the biggest price swings of any industry.
The BLOOMBERG RISKLESS RETURN RANKING shows energy had the top return among the 10 broad industry groups in the Standard & Poor’s 500 Index in the decade ended Jan. 31, even with the second-highest volatility. Energy stocks rose 7 percent after taking into account swings that were greater than for any group except financial companies.
“Volatility is our friend,” said Bryan, who together with Rikard Ekstrand manages the $1.29 billion FPA Capital, the best diversified stock fund over the past 25 years. “It is what gives us opportunities to sell into strength and buy into weakness.”
Growing demand for fuel from emerging countries such as China and India sent energy shares soaring in the past decade as oil prices quintupled. Crude oil’s three-month implied volatility, a gauge for future price swings, fell to a seven- month low yesterday, suggesting price swings may remain limited. FPA Capital had 44 percent of its stock assets in energy at year-end, the most for any diversified domestic equity fund with $500 million or more, according to data compiled by Morningstar Inc. in Chicago.
The risk-adjusted return, which isn’t annualized, is calculated by dividing total return by volatility, or the degree of daily price-swing variation, providing a measure of income per unit of risk.
Energy scored best because its total return was enough to offset its gyrations. The stocks returned an unadjusted 212 percent, including dividends, almost twice the gain of the second-strongest group, materials companies such as paper producers.
Consumer-staples stocks had the second-best risk-adjusted return, at 6.1 percent, and the S&P 500 Index (SPX) increased 1.9 percent.
Even with a concentrated holding in energy stocks, FPA Capital’s price swings were less extreme than those of its benchmark because the fund had 29 percent of assets in cash at the end of last year, according to data compiled by Bloomberg. FPA Capital had a volatility of 25.8 percent in the past 12 months, compared with 27.1 percent for the Russell 2500 Index. The fund also did better over five years.
Taking into account the cash holdings, energy represented 31 percent of the fund’s assets, First Pacific’s website shows. Oil and gas shares make up 12 percent of the S&P 500 Index, according to data compiled by Bloomberg.
The industry can continue to prosper even without rising oil prices because crude is already more than high enough to generate good returns, according to Bryan.
“Our companies are very profitable and still very cheap,” Bryan said in a telephone interview. “We will be very pleased if oil just stays where it is.”
Oil will remain above $93 a barrel through 2015, according to the average of nine forecasters surveyed by Bloomberg. The analysts’ predictions for 2015 range from $82.50 to $137. Eighty dollars is a reasonable estimate for long-term prices in a “normal economic scenario,” Bryan said.
Cabot Oil & Gas Corp., the best performer in the Standard & Poor’s 500 index last year, returned a risk-adjusted 19 percent over the past decade, best among FPA Capital’s top 25 stock holdings as of Dec. 31. The Houston-based company has fallen 7.8 percent this year as more than 80 percent of its operating revenue came from gas in the third quarter.
Among energy stocks in the S&P 500, Range Resources Corp. in Fort Worth, Texas, was the best risk-adjusted performer over the past 10 years, rising 41 percent, followed by Houston-based Southwestern Energy Co. with 40 percent.
The global oil supply will probably remain tight, said Brian Barish, whose $1.31 billion Cambiar Opportunity Fund had 24 percent of its equity assets in energy at year-end, according to Morningstar (MORN)’s data.
“The demand side is going to be there no matter what, particularly from the emerging markets,” Barish said in a phone interview from Denver. “The economics are overwhelming.”
As investors get used to the idea that oil prices are likely to remain “stubbornly high, and are not part of a commodity bubble,” Barish said, they will bid up the stocks.
‘Don’t Get Agitated’
Many oil stocks are priced as if crude will trade at $70 to $80 a barrel, estimates that Barish calls too low. Oil may stay in the $90 to $100 range it has traded in for most of the past 18 months, he said.
“Volatility is a risk only if you get agitated about it,” Barish said.
Those forecasts are too optimistic, according to Michael Lynch, president of Strategic Energy & Economic Research.
“Supply gains are going to be more robust than people think,” Lynch said in a phone interview. Oil may fall to between $40 and $50 a barrel within three years as more drilling and new technology boost shale production overseas, he said.
Oil may dip that low in a global recession, Bryan said. It’s unlikely to stay there, according to the fund manager. Prices took less than year to climb from $34 to more than $80 a barrel when the world economy rebounded in 2009.
Global demand for oil fell 0.5 percent in 2008 and 1.5 percent in 2009, according to data compiled by Bloomberg. “And that was during the worst global recession in 70 years,” Bryan said.
Oil is more attractive than gas, he said, because a glut of supply has depressed prices for that fuel. Natural gas futures fell 32 percent last year, according to data compiled by Bloomberg.
The energy industry’s volatility in the past decade mirrored swings in oil, which surged above $145 a barrel in July 2008 and plunged below $34 that December as the credit crisis slowed the world economy. Crude was the fifth-most-volatile commodity out of 25 in the decade ended Jan. 31, based on the S&P GSCI indexes.
Volatility is unavoidable because of the industry’s sensitivity to the global economy and political tensions in the Middle East, said Bryan.
The European Union agreed Jan. 23 to ban oil imports from Iran, the world’s fourth-largest producer, starting July 1 to ratchet up pressure on the nation to give up its nuclear program.
The Libyan civil war that erupted a year ago threatened supplies from the home of Africa’s biggest crude reserves. The conflict, coupled with unrest in the Mideast and North Africa that toppled leaders in Tunisia and Egypt, drove oil from about $84 a barrel to more than $113 from February to April.
Crude plunged to about $75 by October as fighting ended and concerns grew that U.S. and European economies would slow.
Geopolitical fears may be adding $10 to $15 a barrel to the current price of oil, Daniel Rice, manager of the $1.33 billion BlackRock Energy & Resources Portfolio, said in an e-mail.
Energy holdings dragged FPA Capital to a loss of 35 percent in 2008, the worst year ever for the fund that began in 1984. The stocks helped spur a 54 percent gain in 2009. Crude fell 76 percent in 2008 before recovering much of that loss.
“We are going to take our hits sometimes,” Bryan said.
FPA Capital returned an average of 15 percent annually in the 25 years ended Dec. 31, the best performance among diversified U.S. stock funds with at least $500 million in assets, according to Morningstar. The fund, which focuses on small and mid-sized stocks, was run from 1984 through 2009 by Robert Rodriguez, now chief executive officer of Los Angeles- based First Pacific Advisors LLC.
Bryan, 50, joined FPA Capital in 1993 and became a co- manager in 2007. The managers buy stocks they believe are selling for less than their long-term value, and hold cash when they can’t find enough attractive investments.
Rosetta Resources Inc. (ROSE), Bryan’s sixth-largest holding as of Dec. 31, illustrates the math he uses to evaluate energy shares. The Houston-based company is drilling in the Eagle Ford shale in south Texas, a site with “tremendous potential,” Bryan said. The company expects to increase production there by 40 percent this year, it said in December.
Given projections for rising output, Rosetta can produce enough oil and natural gas from one section of the site to create about $50 a share of value with oil at $80 a barrel, Bryan estimates. A second piece of the property and additional acreage in Montana could make the shares, which closed yesterday at $50.44 in New York trading, worth as much as $80 within five years, Bryan said.
The fund’s turnover ratio, a gauge of how much the portfolio changes in a year, is 14 percent, according to FPA. U.S. stock funds average 84 percent, Morningstar data show.
When oil plummeted in the fourth quarter of 2008, FPA Capital purchased a number of exploration and production stocks, including Woodlands, Texas-based Newfield Exploration Co. (NFX) for as little as $16 a share, Bryan said.
As the stock climbed toward a peak of $76.45 in March 2011, the fund cut its holding by almost two-thirds, Bloomberg data show. Bryan bought more Newfield shares in the fourth quarter of 2011, when the stock averaged about $40.
The fund trimmed its Ensco stake during 2009’s rally and increased and decreased its Rowan holding several times over the past five years.
Taking the long view enables FPA Capital to benefit from price swings in classic buy-low, sell-high style, Bryan said.
“It lets us to scale into and out of euphoria,” he said.
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