World Energy Fund Commentary
Market Overview
As the globe recovers from COVID-19 lockdowns and economic activity accelerates, demand for fossil fuels has extended its rebound in the face of muted output growth. As a result, crude oil inventories persistently drew down throughout the quarter. Despite the rapid growth in demand and constrained supply increases from the Organization of Petroleum Exporting Countries plus Russia (OPEC+) group, North American oil producers continue to deliver meager production escalation, sticking with a strategy favoring shareholder returns over output growth.
Limited production increases and restrained investment have kept inventories low, allowing prices to recover. Furthermore, environmental concerns have resulted in a growing reluctance from governments and private institutions to sponsor carbon-intensive projects. These forces are translating to a state of undersupply and underinvestment in traditional energy resources. This has resulted in the price of crude oil reaching levels not seen since 2018. Although the specter of Iranian oil re-entering markets is somewhat of a wildcard in the near term, more significant is the rising tide of demand that is stripping inventories, which cannot be replaced without the return of idled capacity.
Morningstar Star Rating
Overall Morningstar RatingTM out of 75 Equity Energy funds (for the overall period, Institutional Shares)
Positioning the World Energy Fund
Portfolio composition is subject to change. Throughout the quarter, we shifted the Fund’s position aggressively towards oil and gas, with an emphasis on producers that have a strong oil mix. The oil and gas investments included increasing positions in the oilfield service (OFS), exploration and production (E&Ps), and refining companies. These investments were driven by our goal of increasing the portfolio’s weighting in companies that generally benefit from strong oil and gas pricing dynamics. We added positions in the OFS group based on our belief that eventually higher prices will result in increased investment in new production capacity. Our investments in refining reflect what we view as company-specific catalysts. However, pricing differentials remain a headwind for the broader group, so we believe a nimble hand is key.
We began shifting our alternative energy holdings toward names within the solar, wind, and hydrogen industries as the quarter wore on, while keeping healthy exposure to the battery electric vehicle (BEV) supply chain. We believe that owning shares in suppliers of battery materials and vehicle components is the optimal way to play the BEV adoption narrative, based on more attractive risk/reward story than the untested pure-play BEV producers. Following a selldown in the wind/solar/hydrogen groups in April, we took the opportunity to add back specific companies that we have visited previously at attractive prices.
Our portfolio adjustments during the quarter reflect our confidence in the global economic recovery, as well as a desire to balance the reality of dissipating oil reserves/ inventories with the trend towards renewable energy investments.
Why should investors consider investing in this Fund?
As we move through the economic upcycle, we believe energy remains an attractive industry relative to the broader market. As demand collapsed and investors fled the space during the pandemic, companies in the sector responded by adjusting capital allocation priorities to favor shareholder returns, translating to attractive return potential at relatively cheap valuations. As investors have become increasingly aware of both the dislocation in the long-term supply/demand backdrop, as well as shifting capital strategies from producers, funds have flowed back into the space. As a result, the energy sector has substantially outperformed the market year to date. Despite the strong 2021 performance, we believe the bull run in energy is likely to continue as the sector remains relatively cheap on a valuation basis, and the fundamentals continue to support strong pricing.
While traditional oil and gas remains the industry’s bellwether, we believe that the current landscape requires a flexible definition of what constitutes energy and energy-related holdings. This greater flexibility enables us to invest in all aspects of the broader industry, including renewable energy, while preserving the upside offered by a recovery in fossil fuels. In turn, we believe this could facilitate potentially superior returns than our peers, and offers investors a compelling set of exposures that capture a broader definition of energy.
DISCLOSURES
An investor should consider a fund’s investment objectives, risks and charges and expenses carefully before investing or sending money This and other important information about an investment company can be found in the fund’s prospectus. To obtain a Cavanal Hill Funds prospectus or summary prospectus, please call 800-762-7085 or visit us at www.cavanalhillfunds.com. Please read it carefully before investing.