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Guinness: How our energy fund could make 70% in two years

Oil has rallied recently and Jonathan Waghorn and Will Riley, managers of the Guinness Global Energy fund, argue it could recover further from here.

Daniel Lanyon

By Daniel Lanyon, Senior reporter, FE Tr...
Monday March 14, 2016

Investors could see a 70 per cent return over the next one to two years due to a turnaround in the factors keeping the oil price low, according to Jonathan Waghorn, co-manager of the Guinness Global Energy fund.

The fall in the oil price has continued to dominate headlines this year following its rout in the second half of 2014, which extended into the bulk of 2015. However in the last few weeks, there has been somewhat of a recovery.

At the time of writing the oil price was $38.45 per barrel, which represents a near 70 per cent fall since June 2014, according to FE Analytics

Performance of index since 27 June 2014


Source: FE Analytics

Waghorn, who heads the Guinness Global Energy portfolio alongside Tim Guinness and Will Riley, has been seeking to own “the best quality” energy and oil-related firms during this tricky period to protect against the downside as far as possible.

However, the manager says they soon could go into the more risky, higher beta parts of the market such as small and mid-caps in a belief that a recovery is not far off.

“$30 is not a price that is sustainable. We will come back to a price of about $70-75. We are getting close to a turning point,” he said.

“The [energy] equiteis are pricing $50 per barrel. If it stays around $40 you want to stay well away it if goes to $50, you're going to see 10 to 15 per cent upside. If it goes to $60 then our fund could go to about 30 to 35 per cent [return]. At $70, about 60 to 75 per cent [return] and above that who knows. 

The $223m fund has its largest exposure to large and mega-cap oil firms, such as Suncor and Apache, followed by the battered oil & gas majors such as BP and Shell. But Waghorn says the team at Guinness is poised to snap up small and mid-cap oil stocks.

“We have [focused on large-caps] for six months because we have been defending the downside but we have a shopping list of names that we want to buy. When we are confident that it will work, that is exactly our strategy. It could be in six weeks or six months.”

“We do own Tullow, we could own Genel although we are unlikely to own Premier because of the balance sheet side of things.”

These stocks have all had a torrid few years due to their mid-cap status, which normally means they fall and rise more dramatically than the wider market.

Performance of stocks and index since 27 June 2014


Source: FE Analytics

Greg Bennett, co-manager of the £377m Argonaut Absolute Return fund, is more sceptical.

 “At the start of 2015, the median oil price being used by analysts was $80 and $85 for 2015 and 2016. Currently it is $55 and $58 – a 30 per cent cut in the most important modelling assumption – unsurprisingly resulting in negative earnings revisions,” he said.

“Notwithstanding these earnings revisions, many oil stocks remain resilient. This is because most analysts and investors believe oil will be materially higher in the near future and are looking through current weak earnings.”

However, Bennett adds that he thinks this is under pressure from ongoing over supply.

“The world has been over-producing oil every quarter from the start of 2014. Since oil was last over $100, global production is up 3.6m barrels per day.”

“The largest contributors to supply growth has been Iraq and Saudi Arabia, Russia, the Gulf of Mexico and Asia. Even if, as the IEA expects, US shale production falls by 600,000 barrels per day next year, the world currently over-produces oil by 1.6m barrels per day. Also, global inventories are at levels not seen for more than two decades.”

“The clear risk is oil continues to stay at current levels, or lower, over the near term. Producers will not cut due to economics, while Saudi Arabia is unlikely to cut until it achieves its aims. This would mean significant downward revisions to earnings expectations and valuations for the sector. Equally, it will mean recent M&A and debt issuance, based on budgeted higher oil assumptions, may not be as economical as first thought. A veritable house of cards.”

However, Waghorn disagrees and says the oversupply has been reducing and continues to fall.

“Non-OPEC supply, in terms of the US, is reducing hard and the rebalance has begun. Saudi Arabia has won its approach of taking US oil off the market.” 

“The downside risk has been taken away. There is very little spare capacity that sits outside of Saudi, Iran or Libya.”

The Guinness Global Energy fund has lost 18.84 per cent since launch in 2008, while its benchmark is up 4.35 per cent.

Performance of index since 27 June 2014


Source: FE Analytics

However, it has outperformed substantially in the recent bounce in oil prices.

Jeremy Lang, manager of the Ardevora Global Equity fund, seeks to use cognitive psychology in his investment process to “exploit biases inherent in the three participants in equity markets: company management, analysts and investors.”

He says the current oil market is a good example of this.

“The key debate for the outlook for oil is ‘what is normal’? We think capital intensive Chinese growth and OPEC are not normal conditions in the long-term history of oil,” he said.

“Using the last 20, or even 50 years, as a basis to make predictions about the oil price looks to us to be especially error prone. Hence, businesses which have looked good over the last 10 years may have been relying on conditions unlikely to be repeated.”

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Data provided by FE. Care has been taken to ensure that the information is correct, but FE neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.

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