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 3/31/2016)

The first quarter of 2016 marked another period of volatility for the market sectors in which we invest and, consequently, Baron Energy and Resources Fund. During the quarter, we witnessed another 20% decline in the average price for a barrel of oil, seeing oil prices declining at one point to near 15-year lows of $26/barrel before rebounding to near $40/barrel by quarter end. Significantly warmer than normal weather in the U.S. also led to natural gas prices declining to their lowest level since the mid-late 1990s, averaging nearly 30% less than the year-ago quarter. The stress that these lower prices put on energy equity and credit markets was significant early in the quarter and was particularly acute on small and mid-cap companies. While energy prices were suffering, metals prices, particularly for gold and iron ore, staged a quite unexpected recovery, catching the Fund a bit flat footed, as we had not been invested in these areas for some time. The challenge of investing amidst this period of heightened volatility has been quite severe; but despite the disappointing performance, we believe that the portfolio is well positioned to show improved performance in the upcoming quarters and years.

It is our view that energy markets have bottomed, and while we expect ongoing volatility in the commodities and stocks, we are more convinced that the current industry setup is going to lead to a more sustained business recovery over the next three to five years as hydrocarbon demand grows faster than supply.

Our focus remains on owning companies that we believe have the wherewithal to survive the current environment and thrive as prices recover. With our investments in conventional energy companies, we remain focused on those that have 1) low cost assets and high relative margins, 2) significant resource development potential, 3) strong balance sheets, 4) entrepreneurial management teams, and 5) advantaged competitive positioning. We have also been interested and willing to take on a bit more risk in the portfolio as demonstrated with some of our recent purchases, but even in these cases we have no concerns about financial viability or financial stability and believe that the markets are significantly undervaluing the assets and growth potential of these companies.

Over the long term, we see continued growth and return opportunities for oil & gas companies that have competitively advantaged access to lower cost, long-lived resources. At the same time, as a result of climate change regulation, public policy changes, and technology development, we remain aware of the long-term challenges that the energy industry may face in terms of altering our assumptions about future energy supply/demand, the value of resources and the costs of adapting. We continue to remind ourselves that we run an “energy fund not a hydrocarbon fund” and therefore continue to look for investments that can also capitalize on these regulatory and technology changes. However, we are also mindful of the fact that the real world needs a stable and functioning oil & gas industry to bring increasing growth and prosperity to more parts of the world today and for the future.

Top Contributors/Detractors to Performance

Contributors (for quarter ended 3/31/2016)
  • Parsley Energy, Inc. is an independent exploration and production company focused on the Permian Basin in West Texas. Parsley has a strong balance sheet and a superior acreage footprint that generates some of the highest rates of return in the U.S. Parsley once again delivered strong operational performance in Q1, with solid production outlook, better oil mix, lower capital costs, and most importantly, impressive results from its highly anticipated first horizontal wells in the Southern Delaware Basin acreage.

  • Rice Energy, Inc. is an exploration & production (E&P) company operating in Pennsylvania and Ohio. After we initiated our position in Q1, shares increased due to an improved production outlook for 2016 and rising natural gas prices. In our opinion, Rice is one of the most attractively valued gas-focused E&Ps. It offers industry-leading production growth and exposure to premium Marcellus and Utica acreage. We expect shares to benefit as Rice executes operationally and unlocks the value of its underappreciated midstream assets.

  • RSP Permian, Inc. is an exploration & production company focused on the Permian Basin in West Texas. RSP has extended its core well inventory and provided a strong operational update with capital efficiency that exceeded analyst expectations. Management has effectively removed equity issuance concerns that weighed on shares at the start of 2016. We believe shares will benefit from ongoing improvements in operating results, lower costs, and RSP’s ability to generate high double-digit production growth in the current low oil price environment.

Detractors (for quarter ended 3/31/2016)
  • Energy Transfer Equity, L.P. owns equity interests in energy midstream companies Energy Transfer Partners, Sunoco Logistics, and Sunoco LP. The company’s 2015 bid to acquire a large cap midstream master limited partnership created a significant financing gap in a declining commodity environment and a liquidity crisis, which, in turn, pressured the stock price. We retain conviction based on the company’s premier asset footprint, and strong management team that has proved before to be able to capitalize on market opportunities.

  • Flotek Industries, Inc. supplies chemical additives to the global oil & gas industry. Its proprietary product, the complex nano-fluid (CnF),  is proving extremely effective at increasing productivity. Shares fell due to the sharp decline in drilling and completions activity. Data issues that cropped up in 4Q15 also continued to weigh on shares. Given ongoing declines in drilling and completion activity in the U.S., the near-term outlook remains a challenge, but we believe in the company’s long-term value proposition.

  • Marathon Petroleum Corp. is one of the largest independent refining and marketing companies in the U.S. with operations focused on the Gulf Coast and midcontinent regions. Shares fell in Q1 due to a combination of refining margins that missed expectations and concerns around forward growth expectations for its subsidiary MPLX LP following the completion of MPLX’s acquisition of MarkWest Energy Partners LP. We think Marathon is currently undervalued and concerns are more than adequately discounted in the share price.

Quarterly Attribution Analysis (for quarter ended 3/31/2016)

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 declined 3.94% in the first quarter and trailed the S&P North American Natural Resources Sector Index by 10.20%, due to a combination of stock selection and sector/sub-industry weightings.

The Fund’s investments in the oil & gas exploration & production (E&P), equipment & services, and drilling sub-industries of the Energy sector and its sole Industrials holding contributed the most to relative performance. Strength in E&P was mainly due to the outperformance of Parsley Energy, Inc., Rice Energy Inc., and RSP Permian, Inc., which were also the Fund’s three largest contributors on an absolute basis. Oil States International, Inc. added the most value in equipment & services, while Helmerich & Payne, Inc. aided relative performance in drilling. Within Industrials, shares of Primoris Services Corp., a specialty construction and infrastructure company, rose after announcing a slew of significant projects in the quarter. These announcements added to the company’s already strong backlog and provided additional earnings visibility over the next 12 months.

The Fund’s Materials and Renewable Energy investments, its oil & gas storage & transportation and refining & marketing holdings within the Energy sector, and its average cash exposure of 16.5% in an up market detracted the most from relative results. Weakness in Materials was mostly attributable to the underperformance of Flotek Industries, Inc. and lack of exposure to the strong performing gold and diversified metals & mining sub-industries, which together account for more than one-third of the benchmark’s exposure to the sector. These sub-industries rose 50.2% and 40.2%, respectively, within the index, detracting 208 basis points from relative results. Within Renewable Energy, underperformance of TerraForm Global, Inc. and TerraForm Power, Inc. detracted from relative results. These stocks fell due to uncertainty related to the implications of a potential bankruptcy of parent company SunEdison. We continue to hold these stocks as we believe they are solvent and have enough liquidity to continue operating in the near-term. Underperformance of oil & gas storage & transportation holdings detracted the most from relative performance after declining 16.2%, led by Energy Transfer Equity, L.P., Columbia Pipeline Partners LP, and Scorpio Tankers Inc. Energy Transfer Equity was the largest detractor on an absolute basis, while shares of Columbia fell after its parent sold itself to TransCanada, creating uncertainty around Columbia’s growth plan. We exited our position. Shares of tanker company Scorpio declined as macroeconomic concerns around economic activity and ability to raise capital overshadowed the solid fundamental performance of tankers. Oil & gas refining & marketing holdings Marathon Petroleum Corp. and Valero Energy Corporation also underperformed, but this negative effect was mostly offset by lower exposure to this lagging sub-industry, which declined 8.6% in the index.

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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.