Vanguard Energy: ‘Buy Cheap, Sell Dear’
12/10/2014 10:00 am EST
Following the adage to buy low and sell high, Benjamin Shepherd, believes the sharp sell-off in energy now warrants adding a long-term energy position to the model portfolio at Personal Finance. Here, he discusses his fund of choice for exposure to the sector.
Steven Halpern: Joining us today is Benjamin Shepherd, editor of Global Income Edge and an ongoing contributor to Investing Daily’s Flagship Newsletter Personal Finance. How are you doing today Ben?
Benjamin Shepherd: Great Steven, how are you?
Steven Halpern: Very good, thanks so much for joining us. In your latest research, you point out the well-known market maxim that smart investors make their money by buying when stocks are cheap and selling when they’re dear, and in this case, you apply that strategy to the energy sector. Could you expand on that?
Benjamin Shepherd: Sure, if you read the books that, you know, some of the great investors over the years have written, like Peter Lynch and Warren Buffett, you know, obviously, they have a real edge as far as their analysis ability goes, but they all point to the fact that they buy cheap and sell high.
When you’re an investor, that’s really the way you make your money and when you look at the energy sector today, the price of oil has fallen for about $100 a barrel at the beginning of the year to under $70 now.
We’re getting to the point where it’s probably not going to get a whole lot cheaper than it is right now, so the smart energy investor is going to be starting to look at initiating positions in this sector today and position himself for more profits tomorrow.
Steven Halpern: Now, along those lines, in order to take advantage of the long-term opportunity you see in energy, you added an energy-related mutual fund to your model portfolio, and that’s the Vanguard Energy Fund (US:VGENX). Can you tell us a little about the fund and your reasoning behind adding it to the portfolio now?
Benjamin Shepherd: Sure, Vanguard Energy right now holds a basket of about 122 energy-related companies. About a third of the fund’s assets are devoted to exploration and production companies.
Another third goes towards the integrated majors like ExxonMobil (XOM) and Chevron (CVX), which both produce and refine oil and natural gas products, and one of the reasons I really like the fund is that big allocation to the major integrated companies.
You know, when oil prices fall, companies that are devoted almost exclusively to exploration and production are going to take a real hit, because they’re making all of their money on the margin—how much more they can sell a barrel of oil or natural gas for—versus what it costs them to produce it.
The integrated majors on the other hand, can play the margins in a different way. Not only are they producing the oil and gas, they’re also refining it, and that refining capability and the ability to sell those refined products makes them less sensitive to oil price swings and that, in turn, helps to stabilize the fund’s overall performance.
Steven Halpern: You note that the fund manager has a somewhat unique investment strategy by focusing on what you refer to as long-lived assets. Could you explain that aspect of the fund’s strategy?
Benjamin Shepherd: Sure, the fund’s manager, Mr. Bandtel likes to focus on energy companies that have a lot of proven reserves in the ground.
These are energy companies that can continue pumping oil, say, for the next ten to 15 years just based on what they already have. They’re not dependent on going out and finding new resources to maintain their production.
One major advantage that has is companies that have a lot of resources in the ground tend to be low cost producers. That means they can produce it much more cheaply than most of their peers and that’s a real advantage in times like these when energy prices are falling, because the more cheaply you can produce your energy assets, the more profitable you can be over the long-term, whether the price of oil is at $100 or $70.
So, again, that just goes to adding stability to the fund’s holdings and help minimizing a lot of the volatility that a lot of the other energy funds have because they like to take on more speculative plays.
They like going for the ten baggers, whereas Bandtel is going for maybe a two or a three bagger, but if you do that consistently over the long-term, that’s a lot more money in his investors’ pockets.
Steven Halpern: So that might help explain why the fund tends to favor large-caps. Could you explain how important that is in the environment?
Benjamin Shepherd: Again, it all goes back to volatility. In the energy sector we can see ridiculous price swings and this year is a perfect example of that. Again, like you said, the large-cap companies tend to have those long-lived assets.
They also tend to have the financial wear to withstand these major swings, whereas a lot of smaller producers—like the shell plays that we often talk about here in the US—can actually find themselves priced out of the market.
Obviously, they're not going to produce a barrel of oil if they can only get $66 for it on the market but it costs them $75 to actually pump it out of the ground. They’re better off just stopping operations. Most of the large-caps on the other hand, don’t face that challenge.
Steven Halpern: Now a majority of the fund’s assets are in American energy companies, yet you noted also does offer some international exposure; could you explain?
Benjamin Shepherd: Sure, here in the US, especially when we’re talking about the oil market, we tend to talk about West Texas Intermediate Oil, which is currently trading at about $66 a barrel, but around the world, there are all sorts of different energy markets.
For instance, in Europe, their benchmark is Brent crude, which, trade is based on entirely different market dynamics.
By diversifying his assets across these various foreign companies and foreign countries, he’s able to take advantage of those price differentials between here and Europe, between Europe and Asia, and position himself to take advantage of the most profitable and most attractive energy markets anywhere around the world.
Steven Halpern: Finally, you note that Vanguard is well known for minimizing its fees and its costs. Is that the case with this fund?
Benjamin Shepherd: Sure, any fund associated with Vanguard and Jack Bogle, they’re all about minimizing their costs because, you know, he was one of the pioneers of indexing and he—Jack Bogle—really believes that minimizing costs is one of the key elements of long-term success.
Right now the Vanguard Energy Fund’s expense ratio is just .38%. That’s 38 basis points. That makes it one of the cheapest diversified energy mutual funds available on the market today, so that makes it a great option for long-term buy and hold investors.
If you want to add this fund to your portfolio today, the expenses aren’t going to be a major drag on your returns, whether you sit on it for a year, or sit on it for a decade.
Steven Halpern: We really appreciate you taking the time to join us today. Thank you so much.
Benjamin Shepherd: Thank you, Steven.