As low oil and gas prices are cutting into alternative investment returns, some investors are doubling down, pouring more capital into the sector.
In March, the $12.7 billion Orange County Employees Retirement System, Santa Ana, Calif., committed a total of $200 million to four energy private equity managers. That followed commitments of $175 million to two others in January. OCERS is targeting 25% to 50% of its real return portfolio to energy; its real return target allocation is 8% of the total portfolio.
In a March 25 memo to the OCERS board, Chief Investment Officer Girard Miller said 2015 is an attractive year to invest in energy “when capital will be well rewarded by efficient operators. It is also my view that new energy equity investments will likely produce higher long-term returns going forward than any other strategy in our real return portfolio.”
In June, the C$154.4 billion ($124.9 billion) Ontario Teachers' Pension Plan, Toronto, acquired Heritage Royalty LP from Cenovus Energy for C$3.3 billion in cash. Ontario Teachers was among the pension funds that took the largest stakes in energy companies in the first quarter, a Pensions & Investments analysis of 13F filings revealed. Ontario Teachers took a $33.2 million stake in Bonanza Creek Energy Inc. in the first quarter.
As of year-end 2014, Ontario Teachers had 3% of its C$21 billion private equity portfolio invested in energy and power, 1% of its C$11.9 billion real asset portfolio in oil and gas. It also has a roughly C$9 billion energy and agriculture commodities portfolio.
T. Britton Harris IV, chief investment officer of the $132 billion Texas Teacher Retirement System, Austin, told trustees at a meeting in February that staff members were developing a strategic investment plan for oil and energy that included taking advantage of dislocation in the sector. Texas TRS has a 3% allocation to energy and natural resources with about $2.6 billion — as of Sept. 30 — invested in dedicated energy and natural resources investments. The investment staff has a range of zero to 8% in which to invest.
“If you want to earn an 8% to 10% return, you can do it through this dislocated sector,” Mr. Harris said at the meeting.
Energy has been a darling with investors looking to add yield to their portfolios for a number of years. However, dropping oil and gas prices have taken a bite out of returns. The S&P 500 Energy index is down 28.33% annualized for the year ended July 22.
In November, investors and managers were sanguine about the drop in oil prices, saying if oil got down to $70 per barrel, then portfolios could suffer. Oil dropped to $44 per barrel in January.
Returns have suffered and some other investors have started diversifying out of energy.
The mean internal rate of return for energy private equity funds, as of Dec. 31, has dropped to -4.2% for funds closed in 2013 from 10% for funds closed in 2005, according to research firm PitchBook Data Inc. The median IRR dropped to 4% for 2013 vintage funds from 7.9% for 2010 vintage funds.
“Energy has been very, very popular” with asset owners investing across alternative investment sectors — including private equity infrastructure, and other real assets, said Andrew Brown, senior investment consultant in the London office of consulting firm Towers Watson & Co. “A large part of that was due to shale and fracking in the U.S. ... People were very excited and wanted to be part of that opportunity,” Mr. Brown said. “What had been a huge opportunity became a panic with valuations of oil and gas dropping considerably.”
Managers are starting to suffer. In May, Fortress Investment Group LLC came to the rescue of Mount Kellett Capital Management LP, co-founded by Mark McGoldrick, a former Goldman Sachs Group Inc. executive. Mount Kellett's approximately $3 billion in energy investments dropped in value as oil prices fell. Fortress invested about $200 million in Mount Kellett's funds and basically acquired the firm, co-managing its funds and hired some of its employees. Mount Kellett and Fortress executives declined comment.