September 1, 2021

Lipper Leaders Spotlight—Hennessy Fund Generates Consistent Returns with Energy Investments

by Mike Schnitzel.

The Lipper Classification of Natural Resources Funds focuses on funds that invest primarily in the equity securities of domestic companies engaged in the exploration, development, production, or distribution of natural resources including oil, natural gas, and base minerals, according to Lipper methodology.

The Lipper Leaders Rating System uses metrics to help investors determine funds that might be suitable for their portfolios. According to Refinitiv Lipper, “Each fund is ranked against its peers based on the metric used (such as Total Return or Expense), and the highest 20% of funds in each peer group are named Lipper Leaders, the next 20% receive a rating of 4, the middle 20% are rated 3, the next 20% are rated 2, and the lowest 20% are rated 1.”

Using Lipper Leader metrics, one of the best Natural Resources Funds is the Hennessy BP Energy Transition Fund (HNRGX). The fund has a Lipper Leaders rating of 5 in overall Consistent Return, as well as a 5 over the three- and five-year periods. It also attains the highest rating in Tax Efficiency over the same periods. We spoke with fund manager Ben Cook to examine the strategies he uses to manage the fund, and his outlook on Natural Resources Funds, and energy funds in general.

Low market correlation, energy is historically cheap

The correlation of energy with the broader market is fairly low, said Ben Cook, portfolio manager of the Hennessy BP Transition Fund. His fund has a market correlation of 0.52 over the past year as of July 31. He said the diversification benefits are obvious and that a large part of the market is driven by large-cap technology. “The weighting of energy in the broader market is so small, but I think this is going to change because corporate behavior across the sector is changing, there is value disparity,” Cook said. “Other sectors in the S&P 500 have been stretched—energy is cheap relative to every other sector in the S&P right now historically.”

Cook noted there are a lot of different energy funds in the marketplace today, including passive funds, but many of these funds focus only on hydrocarbons, or solely on renewables. “We have the ability to pivot between those sectors as the investment value shifts from one to the other to maintain the best quality opportunities,” Cook said. He noted energy is the only sector in the S&P 500 trading at a discount on a five-year historic basis to EBITDA. “It’s cheap, the energy sector will benefit from rising interest rates and it is paying out a lot of cash relative to other sectors,” Cook said. “It is good as a means of diversification and for absolute return in a portfolio.”

Investors this year have taken notice of the sector. Lipper Natural Resources Funds have attracted the largest total net inflows through the first seven months of 2021 ($10.4 billion)—the previous record was 2013 ($8.7 billion). Q1 2021 was the largest quarter on record in terms of net inflows for the classification ($8.8 billion), led by a record monthly flow in March ($4.8 billion). The Hennessy fund has taken in $3 million this year and has about $13 million in assets as of July 31.

Putting experience to the test

Cook said the fund’s management has lengthy experience investing in energy since it is a legacy Boone Pickens organization. “Our strategies were created to bring our expertise to a broader sector of the market through a mutual fund strategy. We try to incorporate Boone’s view of the world,” he said. “He was engaged in early wind development in West Texas. His intent then was no different than what we see now as an opportunity to broaden investing in non-traditional sources of power. We’re out there trying to generate return, but I think our approach is the reason we have been successful over the last eight years or so.”

Changes in corporate behavior among energy companies

Cook said energy companies are changing their behavior, paying down debt, and self-funding expenditures, and some energy companies are increasing share buybacks. Corporate governance practices have improved, he said. “Historically when there were strong prices, companies would lever up, and this would lead to disasters when commodity prices plunged. It is far more favorable to invest in a less cyclical manner, being disciplined and growing to a level allowing energy companies to sustain themselves,” Cook said. “This is the function of an industry learning its lesson from previous peaks and valleys from an industry notorious for value destruction due to cyclical investing practices. Investors are used to seeing value destroyed, and investors need energy companies to show they will continue being disciplined.”

A thematic approach to portfolio construction

Broadly speaking, Cook said his fund employs a thematic approach to portfolio construction. The management team has a firm view of both the energy market as a whole and the commodities within that market. “We look at an investable universe of traditional energy, but we include energy end-users as well, and we have the ability to utilize the renewable energy value chain,” Cook said. “Renewable energy has emerged as a big driver of our fund over the past two years.”

Cook said the fund’s management has a repeatable investment process rooted in fundamental valuation, using both relative and absolute value techniques designed to find the best opportunities in energy. Portfolio composition will shift over time to match the best risk-adjusted return potential. From time to time, there are periods where traditional energy companies will screen more or less attractive relative to renewable energy companies, he said.

“The process of selecting stocks and managing risk in a portfolio really starts with our ideas. We have a firm view on commodity or market fundamentals,” Cook said. “Then we have a filtering process that filters candidates in our investable universe that will benefit the most from the themes we’ve articulated. Based on an absolute valuation, we figure which companies are more or less expensive than their peers.”

Cook said the fund manages risk by balancing holdings using risk-reward metrics. “We don’t want to put all of our eggs in one basket, so we make sure to understand the risk of owning each individual security,” he said. “As stocks receive their expected rate of return, we like to rotate out of stocks into other high-grade stocks.” Cook said the fund tweaks themes as new policy emerges, prices change, and consumer behavior patterns change. “There’s probably half a dozen companies we’d characterize for portfolio inclusion,” he said. “Once we have determined a subset of companies that can be screened, we do relative and absolute value screening to determine the best companies in which to invest.”

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