Baron Energy and Resources Fund (BENIX)

Portfolio Management

James H. Stone

Fund Manager since 2011

View All Commentary by James

Fund Description

Baron Energy and Resources Fund invests in securities of energy and resources companies and related companies of all sizes.


Portfolio Commentary

Institutional Performance

Review and Outlook (for quarter ended 6/30/2015)

During the second quarter, oil prices rebounded sharply. While the recovery in price is encouraging as it appears to confirm our views that the worst of the supply/demand imbalance plaguing the oil market for the past 12 months is behind us and in the process of improving, it still was not enough to shift investor sentiment from negative to positive during the quarter. As a result, energy equity performance lagged the recovery in the commodity, and the S&P North American Natural Resources Sector Index declined by 2.67%. Investor sentiment toward the energy industry remained historically low as investors seemed to lack confidence in the forward outlook for a strong and sustained recovery in energy prices amid the current period of oversupply of oil and natural gas.

Despite the difficulty of the investment environment that we faced in the second quarter, which really materialized over the last four to six weeks of the quarter, we still managed to produce modestly positive results on an absolute basis and strengthened our results on a relative basis. In the second quarter, Baron Energy and Resources Fund managed a gain of 0.19% while our benchmark fell 2.67%. Year-to-date, the Fund is up 1.92% compared to a loss of 4.14% for the benchmark. Furthermore, we have seen our three-year and since-inception results move to a premium relative to our benchmark and peer funds. We believe that the performance on a year-to-date and three year basis are positive reflections of our investment strategy and our research and stock selection process. In fact, about 85% of our year-to-date relative outperformance can be attributed to stock selections rather than portfolio allocation effects.

While the outlook for oil markets continues to dominate the conversation around investing in the energy and resources sectors, it is not the only thing on which we are focused in terms of our investment strategy. We have increased our exposure to the renewable energy sector with additional investments in existing positions as well as a new position in the sector and we continue to look for more opportunities. As the levelized cost of electricity from renewable power technologies such as solar and wind continue to decline to or below the costs for conventional power sources, the need for government subsidies and interventions decreases and economic decisions are in sync with policy decisions. This is happening in many parts of the U.S. and the rest of the world and as such is increasing the total addressable market for renewable energy and increasing the investment opportunity.

As we look into the second half of the year, we expect that volatility will continue to be a big part of the landscape but we also anticipate that industry fundamentals are bottoming and should show improvement heading toward and into 2016. The energy and resource sectors remain as out of favor with investors as at any time in the past decade and perhaps longer and we think this creates an opportunity to take a contrarian approach. We believe that valuations are attractive and we are looking to deploy capital to take advantage of this opportunity and these values.

Top Contributors/Detractors to Performance

Contributors (for quarter ended 6/30/2015)
  • Shares of SunEdison, Inc., the world’s largest renewable energy developer, rose in Q2, driven by the announcement of several acquisitions in emerging markets and an IPO filing for TerraForm Global, SunEdison’s emerging market “yieldco.” SunEdison also announced that it is considering a General Partnership structure to better recognize the value of the incentive distribution rights it will receive. These announcements were viewed positively as investors gained confidence that the company will successfully execute on its strategy.

  • Golar LNG Ltd. is a liquefied natural gas (LNG) midstream services company. The stock rebounded in Q2 on news of progress in Golar’s liquefaction projects. We see LNG gaining share in the global energy trade and Golar as a direct beneficiary of this trend. While LNG projects have long lead times and shifts in timing may create short-term disruption to pricing and earnings, with its current fleet and future liquefaction projects, we see Golar’s long term earnings capacity as significantly higher than what current financials suggest.

  • Parsley Energy, Inc. is an independent E&P company focused on the Permian Basin in West Texas. The improvement in oil prices, coupled with ongoing improvements in Parsley’s horizontal drilling results, gave investors increased confidence in the company’s value creation potential. Parsley’s competitive position in the Midland sub-basin of the Permian is looking stronger as it further delineates its acreage and proves its operational prowess. We see the shares as undervalued.

Detractors (for quarter ended 6/30/2015)
  • Bonanza Creek Energy, Inc. is an independent E&P company operating primarily in Northeast Colorado. The shares declined sharply following a credit rating downgrade in May to below investment grade. We believe Bonanza Creek has ample liquidity to weather this period of low oil prices and has made significant gains at reducing well costs and capital spending to better match its cash flows. Improved access to infrastructure will, we believe, also help results in the second half of the year. We view the shares as undervalued at current prices.

  • Flotek Industries, Inc. is a leading supplier of specialized chemicals to the oil & gas industry. Its proprietary citrus oil-based products experienced rapid growth in connection with the boom in shale oil drilling in North America. Despite this, the sharper-than-expected decline in U.S. drilling and completion activity has taken a toll on its earnings outlook and share price during the last couple of quarters. We see significant potential for differentiated organic growth and a rebound in long-term earnings power at Flotek.

  • Gulfport Energy Corp. is an independent E&P company focused primarily on the Utica shale in eastern Ohio. Gulfport has a premier acreage position that has been enhanced through recent acquisitions and a strong balance sheet. However, the shares declined sharply following the company’s second acquisition of a competitor in as many months coupled with an equity offering to fund the deal and weakening Appalachian gas prices. We think that these pressures will prove transitory and that Gulfport shares remain attractive.

Quarterly Attribution Analysis (for quarter ended 6/30/2015)

When reviewing performance attribution on our portfolio, please be aware that we construct the portfolio from the bottom up, one stock at a time. Each stock is included in the portfolio if it meets our rigorous investment criteria. To help manage risk, we are aware of our sector and security weights, but we do not include a holding to achieve a target sector allocation or to approximate an index. Our exposure to any given sector is purely a result of our stock selection process.

Baron Energy and Resources Fund increased 0.19% in the second quarter and outperformed the S&P North American Natural Resources Sector Index by 286 basis points, primarily due to stock selection.

Outperformance of investments in Energy, Renewable Energy, and Industrials and lower exposure to the lagging Materials sector contributed the most to relative performance. Within Energy, oil & gas storage & transportation and oil & gas exploration & production (E&P) holdings were the main contributors to relative results. Oil & gas storage & transportation investments, which increased 3.8%, consist mostly of master limited partnerships (MLPs) and general partnerships (GPs), and outperformed their index counterparts, led by Golar LNG Ltd., Tallgrass Energy GP, LP, and Shell Midstream Partners, L.P. Golar was the second largest contributor on an absolute basis, while shares of Tallgrass, the GP of a fast growing MLP that owns transport, storage and processing assets primarily in the Appalachian Basin, performed well following its IPO in early May. Shares of Shell, an MLP created by Royal Dutch Shell to own and operate midstream assets in Texas and Louisiana, increased nearly 20% after the company announced it was increasing distribution by 7.7% and acquiring additional interest in its IPO assets in order to maintain its growth path. Strength in oil & gas exploration & production was mostly attributable to the outperformance of Parsley Energy, Inc. and RSP Permian, Inc., which are both independent E&P companies focused on the Permian Basin in West Texas. Parsley was the third largest contributor to absolute performance, while RSP’s shares benefited in the quarter from a confluence of higher oil prices and improved operating results. Despite cutting back on drilling in the face of lower oil prices early in the year, RSP still managed to beat production expectations and drive its drilling and operating costs lower. Within Renewable Energy, outperformance of SunEdison, Inc., which is classified by GICS as Information Technology, added the most value. The company was the largest contributor to absolute and relative performance in the quarter. Within Industrials, MRC Global, Inc. and Primoris Services Corp. contributed to relative performance after better-than-feared earnings results combined with attractive valuations caused their stock prices to increase during the quarter.

Underperformance of Materials investments detracted the most from relative results, but this negative effect was partly offset by its lower exposure to this sector, which declined 5.2% in the index. Weakness was mostly attributable to the underperformance of Flotek Industries, Inc., the second largest detractor on an absolute basis, and Westlake Chemical Partners LP, a petrochemical MLP. Shares of Westlake declined after the IRS floated a proposal that would cause petrochemical companies to lose their MLP status.

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The prospective performance of the companies discussed herein is based on our internal analysis and reflect our opinions only. We cannot promise future returns and our opinions are a reflection of our best judgement at the time of publication. Our views are not intended as recommendations or investment advise to any person and are subject to change at any time based on market and other conditions and Baron has no obligation to update them. Investing in the stock market is always risky. Current and future portfolio holdings in the Fund are subject to risk.

Source: FactSet PA.