Oil has been an incredibly volatile investment over the past twenty years, resulting in around 13% annual growth as an industry with a standard deviation of well over 7%. As a value investor the idea of investing in companies that can be seen as necessities to our current way of life is incredibly attractive, however, I need to figure out how to negate a certain amount of risk that can be see with this industry.
Here is the oil industry(Drilling and midstream) plotted against the S&P 500 over the past twenty years.
I’ve recently spent some time reading up on Kristian Siem(put link here), and I’ve decided that for this strategy I will be focusing on only drilling and midstream oil companies.
Secondly, I want to make sure that I’m focusing solely on value investments. I can do this by stating that I only want companies whose value score ranks in the top 70% of all companies within this industry. I also only want companies that give a dividend so I’ll go ahead and put a field that states that dividend yield needs to be greater than 0.
Here are our results for that specific strategy.
We return an average of 18% annually. However, we do this is a standard deviation of greater than 7 and we took part in massive drops in 1998, 2008, and 2015. My goal is to eliminate these extremes and create a more bond like investment.
What happens if we create max holdings of 20 positions ordered by the companies change of close over the past year?
We do a bit better; there’s a lower standard deviation and you gain an extra 2% annually but you are still getting crushed in those three years.
Our founder, Henry Crutcher, is currently working on a white paper based on the seasonality of certain investment strategies, so that gives me an idea… is oil seasonal? Let’s go ahead and add a parameter that we can only trade in the first four months of the year.
Alright! As you can see it worked! If we trade in the first four months of the year we are able to capture tremendous upside making 13% annually with a standard deviation that is lower than both of our benchmarks(All oil and gas companies in the drilling and midstream sector and the S&P 500). Not only that but over the past twenty years we only lost money once in 1997 and that was a minor loss of -1.468%). Past that we’ve made money every year including 1998, 2008, and even in 2015 when the majority of oil companies were dying off thanks to the major crash in oil.
The next question is whether or not this same ideology works within other seasons. In short, without posting a bunch of screenshots, the answer is no. Once you adjust the seasons to trade in the later months you begin to lose money over more years and increase your standard deviation without a significant increase in overall annual returns.
This leads to more questions that need to be tested along the rest of our value strategies, but that’s for another article.
Overall, if you’re going to invest in value oil companies and you’d like a low standard deviation with consistent annual returns jump in on the first of the year and get out before May.