Flexing After an Energy Boost

By TIM GRAY

OIL and gas stocks helped propel the returns of three of the top-performing mutual funds in the first quarter. Only one of the three — the Fidelity Select Energy Portfolio— is, by charter, a dedicated energy investor. The others — the FPA Capital fund and the Metzler/Payden European Emerging Markets fund — have more freedom to roam, but their managers unearthed values in the sector and seized them.

Rebound for Refiners

For John P. Dowd, manager of Fidelity Select Energy, bets on refiners of crude oil have helped power double-digit returns of late. American refiners like Frontier Oil and the Holly Corporation, which recently agreed to merge, were a contrarian bet when he started to accumulate them, he said. Some analysts had believed that domestic oil demand had permanently peaked, leaving excess refinery capacity.

“As a result, the business of taking crude oil and turning it into gasoline was viewed as unprofitable, and these companies were very cheap,” Mr. Dowd said. Tough times winnowed the sector, and survivors streamlined their operations. Rebounding demand has brought renewed profits.

The energy industry is more international than many, but Mr. Dowd’s fund has a domestic slant by plan. All of its top 10 holdings at the end of February were listed in the United States. The largest, at a hefty 16 percent of assets, was Exxon Mobil. That investment may seem oversized — many funds’ holdings of individual stocks top out at about 5 percent — but Mr. Dowd said the stake reflected the quality and breadth of the business. Exxon drills for oil and gas, is the world’s largest oil refiner and is a chemical producer.

“During the recession, Exxon was viewed as a safe haven, and it got very expensive,” he said. “So at one point, the fund owned no Exxon. But it’s no longer expensive.” In early April, Exxon Mobil had a forward price-to-earnings multiple of about 10, making it less expensive than the average company in the Standard & Poor’s 500-stock index.

In the first quarter, Mr. Dowd’s fund, which has $3 billion in assets, returned 18 percent. It has an expense ratio of 0.9 percent. He has managed it since 2006.

Big Bets and Cash

Like Mr. Dowd, Dennis M. Bryan and Rikard B. Ekstrand, co-managers of the FPA Capital fund, are willing to bet big: their fund held only 20 stocks at the end of 2010. Even more striking, it had a huge amount of cash — 30 percent of its $1.4 billion in assets.

Stock fund managers are often reluctant to sock away that much cash. Mr. Bryan and Mr. Ekstrand said their stake wasn’t an investment per se but accumulated because they recently have found few stocks cheap enough to risk buying. They want only shares they gauge to be “absolutely cheap,” not just less expensive than competitors or the market as a whole, Mr. Ekstrand said.

“We’re looking for a stock selling at substantial discount to what we think it’s worth,” he said. “We don’t want to buy stuff where we think there’s only a 20 percent upside.”

In doing their research, they pay particular attention to balance-sheet strength, which shows the ease with which a company can pay its bills and invest in its business. “If a company has a bad balance sheet, it’ll tend to do desperate things when it comes under pressure, like issuing stock or high-interest-rate debt,” Mr. Ekstrand said.

Lately, Mr. Bryan and Mr. Ekstrand have found fare that is cheap but sturdy in the energy sector. Among the fund’s top 10 holdings in December were shares of five energy-related companies, including its biggest holding, Ensco, a British oil driller. FPA Capital typically has an annual turnover rate of only 20 percent, versus about 90 percent for the average stock fund.

The managers’ hard-core value hunting also led them to an often-overlooked sector: railcars. The fund accumulated a stake in Trinity Industries, a big American railcar maker, during the financial crisis.

Like many companies, Trinity was hurt by the recession and it reported a loss in 2009. But the company’s fortunes rebounded with the economy, and Trinity returned 38.1 percent in the first quarter.

FPA Capital returned 13.2 percent for the period; it carries an expense ratio of 0.86 percent. Mr. Bryan and Mr. Ekstrand have been part of the fund’s management team since 2007, when they joined Robert L. Rodriguez, who had overseen it since 1984.

Eyes on Eastern Europe

At first glance, a fund specializing in Eastern Europe might not seem a natural home for oil stocks. After all, the region, as defined by the Metzler/Payden European Emerging Markets fund, stretches from the bazaars of Turkey to the Baltic shores of Estonia. But look again, and the reason becomes obvious. Russia dwarfs the rest of the economies in the region, and energy is that country’s dominant industry.

Thus the Metzler/Payden fund holds big stakes in large Russian energy outfits like Lukoil, Gazprom and Rosneft. The three accounted for nearly 19 percent of the fund’s $176 million in assets at the end of February. Over all, Russian investments made up more than half of the portfolio.

The fund’s lead manager, Markus Brück, said that preponderance was unusual, “a historic high for us,” as he typically aims to invest no more than 30 to 40 percent of his shareholders’ money in Russia. He also says he tries to distinguish his fund by defining Eastern Europe more broadly than competitors who emphasize only Russia, Poland, Hungary and the Czech Republic.

A broader mandate means better diversification opportunities, he said. So, while his fund owns a Russian electronics retailer — M.Video — it has also invested in Tallink, a ferry operator in Estonia. Tallink’s ships crisscross the Baltic Sea, connecting Estonia’s capital, Tallinn, with such places as Helsinki and Stockholm.

In the last few years, emerging markets have been in vogue among investors. But much of the attention has been directed to Asia, especially China and India, not Eastern Europe. Even Russia, which represents the “R” in the ballyhooed BRIC countries, has not attracted the interest that Brazil, China and India have.

Mr. Brück said that overlooking Eastern Europe would be a mistake. Much of the region offers emerging-market growth with some of the safeguards for investors in Western companies, he said. “You have the rules of the E.U., which brings relatively high safety compared with the Asian emerging markets,” he said. “And E.U. authorities are strongly supporting development in the region.”

His fund returned 10.4 percent in the first quarter and has an expense ratio of 1.5 percent. He has managed it since 2002.