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Burned by oil, some U.S. fund managers still bet on rebound

Wed 19th August, 2015 7:10pm
By David Randall 
    NEW YORK, Aug 19 (Reuters) - Mutual fund managers who 
believed the slump in oil prices would be short-lived have been 
taking it on the chin, but some are not giving up, betting that 
the market will bounce back and they will have the last laugh. 
    The FPA Capital Fund, the Towle Deep Value Fund and the 
Mount Lucas US Focus Equity fund are among several that are 
still plowing money into oil exploration and production 
companies, even as their performance numbers sank to the bottom 
5 percent this year, according to Morningstar. (Graphic: 
    Their reason for buying oil stocks even as crude prices are 
tanking again after a tentative second-quarter recovery? A bet 
that U.S. production will retreat sharply over the next 12 
months, setting the stage for a rebound towards $65-70 per 
barrel that would allow most U.S. shale oil producers to stay 
profitable in the longer term.  
    U.S. crude  CLc1  hit 6-1/2 year lows below $41 a barrel on 
Wednesday, weighed down by oversupply concerns, swelling 
stockpiles and fears that China's slowing economy will sap 
global demand. 
    "We're setting ourselves up for the next cycle," said Dennis 
Bryan, co-portfolio manager of the $950 million FPA Capital 
Fund. The fund has about a fifth of its portfolio in oil-related 
stocks, according to Lipper data. 
    Bryan, who points to surveys that estimate that U.S. oil 
companies have cut their capital expenditures by 35 percent this 
year, expects the supply glut to ease by the end of this year. 
    His view is rosier than that of a growing number of 
executives and analysts who are bracing for "lower for longer" 
oil prices, predicting a relatively small dent in U.S. 
production and new supplies from Iran. The International Energy 
Agency expects global oil supply to outstrip demand until at 
least the third quarter of 2016. The deepening pessimism pushed 
energy sector stocks in the S&P 500 down nearly 13 percent this 
year, compared with a 3.3 percent rise in the main index. 
    Bryan's fund is down 8.4 percent and investors have pulled 
$237 million from it over the past 12 months, according to 
Lipper data. In all, the 10 diversified US equity funds with the 
largest energy allocations saw nearly $900 million in outflows, 
shrinking to $3.2 billion over the past 12 months. 
    In contrast, funds that threw in the towel on energy over 
the last year have outperformed. The $17.5 million Tanaka Growth 
fund, for instance, slashed its energy holdings from 17.2 
percent of assets to just 1.2 percent over the past 12 months, 
according to Lipper. The fund has returned 14.7 percent this 
year landing in the top 1 percent of mid-cap funds tracked by 
    Yet some oil analysts think that crude will bottom out soon. 
Paul Horsnell, head of commodities at Standard Chartered, told 
clients in a note on Monday that he expected a "sharp rise in 
prices next year." Raymond James analysts, meanwhile, see oil 
staying below $60 per barrel in 2016, but significantly 
rebounding in 2017.  
    Timothy Rudderow, co-portfolio manager of the $53.9 million 
Mount Lucas US Focused Equity fund, said that he has boosted oil 
exposure following his fund's model that suggests oil stocks 
will rebound over the next 12 months. The fund now has 30.2 
percent of its assets in energy, compared with 7.3 percent a 
year ago, according to Lipper data.  
    Among Rudderow's picks are companies such as Diamond 
Offshore Drilling Inc  DO.N , whose latest quarterly earnings 
handily beat analyst's forecasts, and Transocean Partners LLC 
 RIGP.N , which also beat estimates after what it called "near 
fanatical" cost-cutting.  
    Even so, shares of both companies are down by nearly a 
quarter or more so far this year, one reason why Rudderow's fund 
is down 2.2 percent for the year. 
    "When oil started falling people sold everything that wasn't 
nailed to the floor," Rudderow said. "We're willing to take some 
short-term pain to outperform over the long run."  
    Craig Hodges, co-portfolio manager of the $2.1 billion 
Hodges Small Cap fund, managed to stay in the black despite the 
downdraft even with 7 percent invested in energy, roughly double 
the average for among small-cap funds tracked by Morningstar. 
    His secret? Selective stock-picking and a bit of hedging. 
    As oil prices started to slide in the second half of last 
year, Hodges consolidated his position, putting the money that 
he had spread out across 10 energy stocks into the five 
companies he thought had the strongest balance sheets and 
positioning to weather the downturn. He sold companies including 
U.S. Silica Holdings Inc  SLCA.N , which makes proppants used in 
shale drilling, and Sanchez Energy Corp  SN.N , a fracking 
company located mostly in the Gulf Coast. He held on to 
companies such as Matador Resources Co, RSP Permian Inc 
 RSPP.N , and Diamondback Energy Inc  FANG.O , which operate 
low-cost shale oil fields in Texas. 
    At the same time, Hodges began raising stakes in companies 
that could benefit from cheaper oil, such as American Airlines 
Group Inc  AAL.O , concrete maker Eagle Materials Inc  EXP.N  
and discount retailer Shoe Carnival Inc  SCVL.O . 
    The fund is up 3.3 percent for the year, which puts it in 
the top third of its category.  
    "We want to focus on the survivors and those that have the 
balance sheets to withstand much lower oil prices," he said. "At 
the same time, cheaper energy is a net positive for the economy 
as a whole, and we're trying to tap into that." 
 (Reporting by David Randall; Editing by Linda Stern and Tomasz 
 ((; 646-223-6607; Reuters 
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