“I’ve heard people say we’re in a value cycle now, but it doesn’t feel like a value cycle, it feels like an energy cycle and a tech downdraft. Those are the two bookends,” he says.
“We’re in a market right now where energy and gold are working and everything falls into the category of calm or moderately not working.”
War in Ukraine and the resulting sanctions against Russia, a major oil producer, have helped to drive energy commodities higher. However, the price of gas, coal and oil in particular are likely to remain elevated, Mr Kinkelaar says.
“The old saying is ‘the solution to high oil prices is high oil prices,’ because that typically stimulates increased supply. We haven’t seen that in this cycle.”
The lack of supply and buoyant energy prices will drive profitability for fossil fuel companies, delivering returns for investors that are free from sustainable investing constraints and able to own oil and gas companies.
“I think it will frustrate some people who would prefer energy companies not to make profits, but the dynamics in place might actually make higher profits for the companies in that space,” Mr Kinkelaar says.
The rise of environmental, social and governance (ESG) investing, one of the hot corners of the funds management business over the past decade, has limited the ability of investor capital to support oil and gas exploration while demand for the commodities remains stable.
“Every market has its own challenges,” says Brad Kinkelaar, senior portfolio manager for Barrow Hanley. Oscar Colman
Although privately held companies and businesses attached to oil-producing nations have continued to drill for oil and gas, “there are some companies that are limiting their capital expenditures into drilling,” Kinkelaar says.
“With the lack of drilling from typical sources, the supply and demand mismatch should get exacerbated into higher oil prices.”
The imbalance in supply and demand has helped propel oil and gas producers higher, with the gains enjoyed by a narrowing set of investors.
Barrow Hanley’s global value portfolio has taken a long-term bet on Hess, a US-listed company with offshore drilling rights in oil fields off the coast of Guyana in South America.
The company owns a third share of the Stabroek Block, a 2.7 million-hectare offshore oil field, and said in January it was on track to produce 220,000 barrels of oil a day.
Hess shares have jumped nearly 50 per cent in the past year with the bulk of gains coming in 2022 after the company deduced the Stabroek Block held an additional 10 billion barrels of oil more than initially anticipated.
Stabroek is “one of the most exciting new drilling fields in the world,” says Mr Kinkelaar, and the amount of oil available means it will “transform Hess as it will significantly increase the size of the company”.
“In this environment where people are worried about where extra supply will come from, there is no way Guyana will stop drilling and developing that field. It has a long growth profile ahead of it.”
The mixed market dynamics this year have favoured value investors. The MSCI World value index, a benchmark of large and mid-sized value companies, has traded flat since the year began, while its growth counterpart has fallen 12 per cent.
The declines partly reflect the tightening of monetary policy that has crushed the value of technology companies after a stellar run through the pandemic.
Technology companies make up a vast chunk of the growth equity universe and higher interest rates (and the inflation they reflect) erode the present value of future profits, hurting businesses that investors are betting on for dramatic earnings growth in future years.
The broad derating of tech companies in line with interest rate expectations has opened up pockets of opportunity for value managers such as Mr Kinkelaar to hunt in an exciting sector that usually falls beyond his remit.
“I’ve been managing global value portfolios since 2002 and I don’t think I’ve ever had a period where I was market-weight in tech,” he said. “With the recent weakness in tech it’s a natural place we want to go shopping and find attractive value.”
Value managers typically stick to mature tech businesses such as Oracle, Larry Ellison’s back-office behemoth that has staked a name providing dull yet vital systems in human resources and accounting.
But the dip in tech shares this year has been such that Mr Kinkelaar has even begun scouring the more glitzy end of the sector, pushing him towards the types of companies that have been strictly the domain of growth managers.
“I would love to own those companies too. However, I want to buy at a value price, not because I need to keep up with a benchmark, but because the companies are truly undervalued,” he said.
“Over time, those companies will eventually come back to earth on a valuation basis, so we might be able to own some of them.”
One corner of the sector that Kinkelaar and his team have aggressively pushed into is Chinese technology.
Barrow Hanley’s portfolio managers think investors overreacted to strict new regulatory limits on monopoly businesses such as Alibaba, the e-commerce giant, Baidu, an internet conglomerate that runs a popular search engine, and Didi, the ride-hail group.
Didi shares are down more than 80 per cent from its IPO price last year, while Alibaba shares have shed two-thirds from their peak in October 2020. Baidu trades 60 per cent below its high in February last year.
Barrow Hanley snapped up stakes in Alibaba and Baidu after gauging that the shares would likely enjoy an uplift from calming government rhetoric.
“The valuations were cheap enough that it allowed us to take stakes in some of the leading technology companies in the world,” Mr Kinkelaar says.
“All you had to get was [government policy] stabilisation, which was a low bar. It wasn’t guaranteed but it was a low bar. If you look back at the [Chinese Communist Party] communication, they gave you a playbook but it was cryptic.”
The official line has since shifted alongside a dimming growth outlook for China in a twist that will benefit the same businesses the government has previously targeted.
“In March, [the government] came out again and pledged to protect the market from policy havoc,” the fund manager says. “They’re telling you, ‘we’re done, we need to grow the economy and let the markets participate’.”
Parsing the tea leaves of official Chinese policy, and even decoding the effects of modern military strategy in eastern Europe, are among a handful of tasks that have further complicated the work of fund managers following the tumult of the pandemic.
“I don’t ever remember being in this business and saying ‘this is easy’,” says Mr Kinkelaar.
“It’s a unique environment. But today’s uniqueness will change into something different six months from now,” he says. “Every market has its own challenges.”
