Californians may be parched from a drought that is plaguing the state, but funds from Golden State institutional investors and high-net-worth individuals are flowing into asset management firms. And as a sector that is propping up the U.S. economy with its robust returns, energy investments are attracting a sizeable portion of these funds.

Oil and Gas Investor asked a couple of investment officers recently about the proportion of their funds directed to energy companies and their top picks.

E&Ps with upside

Started by the founder of Kinko’s, West Coast Asset Management takes an entrepreneurial tack in its investments for high-net-worth individuals as well. The Santa Barbara, California, asset manager, with about $175 million under management, is not bound by restrictions that limit many of its peers, and its favorite stocks range in market capitalizations from $60 million to $80 billion.

“We’re very entrepreneurial in our approach,” says chief investment officer Atticus Lowe. “We’re opportunistic in our selection process, and our investments are focused in a small number of companies because we want to be rewarded when we are right. If we think a large company is a more attractive investment than a small company, we’ll own the larger one—and vice versa. We evaluate every company as though we were going to acquire the entire business.”

WCAM’s separately managed portfolios of publicly traded companies have weighed in at 30% energy, and a much higher percentage in the private partnerships that it manages, all in upstream E&Ps. Although the firm once targeted microcaps, the evolution of unconventional resource plays has broadened its focus as the market became more efficient.

“Larger companies are becoming more attractive, because many have substantial resource potential that is not priced into their shares as much as it is for smaller companies. A number of larger companies that have substantial exposure to unconventional plays provide a lot of upside potential and are very inexpensive based on traditional industry valuation metrics.”

Oil-weighted names remain his focus, as “we think gas has a way to go before it recovers, and most oil companies have gas optionality should prices recover.”

Lowe doesn’t anticipate E&Ps will switch to gas projects as long as oil prices remain stable near current levels, and exporting liquefied natural gas (LNG) won’t have the impact that many are hoping for.

“Gas only has so much upside—there’s an incredible amount of supply that can be easily attained if the price is right.”

Specifically, West Coast is looking for investments in companies that are attractive based on the value of their proved reserves, “which offer substantial upside potential through undeveloped acreage in emerging unconventional oil resource plays.”

One company Lowe particularly likes is ConocoPhillips (NYSE: COP), which he believes has 50% upside from its price in mid-January. The $80-billion market cap E&P is an overlooked gem, he believes, due to its spinoff as a pure-play E&P—now the largest in the U.S.—from its downstream counterpart, Phillips 66 (NYSE: PSX).

“It wasn’t on a lot of E&P investors’ radars because they weren’t looking at integrated companies,” he says. “I think it’s mispriced, and I don’t think it will be for long.”

Conoco holds large, strategic positions in prime plays, including the Permian Basin, the Eagle Ford and Bakken shales, as well as a diversified international portfolio. Its reserves are 60% oil, a benefit in today’s market. The stock yields more than 4%, and trades at 4.5x EBITDA, less than $15 per proved barrel of oil equivalent (BOE). It also is a lower-risk investment because of its low valuation compared to its peers, diversification of assets and commodity mix.

“It’s just really cheap, and they’re quality assets,” he says. “It’s unusual for us to own such a large E&P, but we like it.”

Apache Corp. (NYSE: APA), however, “is just dirt cheap— even cheaper than Conoco.”

Apache, at $30 billion in market cap, is the No. 1 driller in the U.S. with nearly 80 rigs deployed. It is the top driller in the Permian Basin and No. 2 in the Anadarko Basin. “It has an almost endless supply of high-quality drilling prospects. Like ConocoPhillips, it is also diversified internationally, giving it a high margin of safety,” Lowe says.

Yet the stock trades at $15 per proved BOE, and only $50,000 per flowing BOE. It has trailed peers on these metrics for some time. Why own now?

“The stock yields only 1%, but I expect the company to significantly improve its dividend, which could be a catalyst for Apache to attract more investor attention,” Lowe says. “Meanwhile, the company has grown and improved its balance sheet. It gets to a point where it’s just too cheap.”

Given Apache’s size and asset base, he views the company as a prime takeout target by a major or international oil company.

“The assets are high quality and it’s cheap— you have to own it.”

Another company he sees as a likely acquisition target and stock to own is Whiting Petroleum Corp. (NYSE: WLL), a $7-billion producer focused on the Bakken and Niobrara shale plays in the Rockies.

“The company has thousands of high-return drilling locations. Compared to other companies that offer a lot of resource potential upside, it’s attractively priced.”

Whiting trades at $20 per proved barrel, under $100,000 per flowing barrel, and less than 5x EBITDA.

“By conventional metrics, it’s attractively priced, and the resource acreage just has multiples of the current price in terms of upside potential value. Whiting can either capture that by continuing to aggressively drill out its projects or by somebody coming along and writing it a check. I think there is a good chance that will happen.”

On the smaller end, with a $1-billion market cap, Lowe chooses W&T Offshore Inc. (NYSE: WTI). “We like it because it’s a cash cow, with regular and special dividends approaching 10% each year, and it’s dirt cheap based on cash-flow multiples.”

The company features recent deepwater Gulf of Mexico discoveries, as well as a large unconventional onshore development in the Permian Basin and additional resource potential in East Texas. It trades at 2.5x cash flow and 3.5x EBITDA, and has nearly a half a billion dollars of liquidity.

“It is trading at the low end of its historical range. You’re getting the onshore assets for free because its traditional business is priced so attractively. For a company that size, it should really be able to move the needle in terms of growth.”

Lowe is also excited about West Coast’s investment in a small, publicly traded company, EnerJex Resources (OTC: ENRJ), of which he is a director and was involved in the company’s transformation at the end of 2010. EnerJex sits on a platform of long-lived producing oil wells in Kansas with hundreds of low-risk drilling locations.

Yet perhaps its best opportunity for growth comes from a third-quarter 2013 acquisition of Black Raven Energy that added nearly 100,000 net acres in the Denver-Julesburg Basin in northeastern Colorado and southwestern Nebraska. In addition to 150 natural gas drilling locations with attractive economics at current prices, the prize is Adena Field, a former Unocal oil project that has been largely shut in since oil prices collapsed in the mid-1980s. It is the third largest oil field in the history of Colorado.

“The company has a lot of running room, and its projects have outstanding economics,” Lowe says. And the company’s D-J Basin acreage is on trend with a number of emerging oil resource plays that “are essentially a lottery ticket.”

Value over time

At TCW Group, equity portfolio manager Diane Jaffee steers investments toward value first.

“Our investment philosophy is, ‘The search for value, poised for growth.’ We go from the bottom up, so the company has to not only be attractively valued, but also have specific catalysts over a couple of years,” she says. “We look at five valuation characteristics, then we look at correlation analysis to determine which ones are the most relevant to that particular company.”

TCW, based in Los Angeles, has some $132 billion under management, with $20 billion in equities. Jaffee, who is in New York, oversees

$7 billion earmarked for relative-value strategies. Within her portfolios, 10% to 12% is directed to energy investments presently, from mid-cap on up. To make it into her portfolio, a company has to meet at least one of the five valuation characteristics, and exhibit at least a 30% appreciation potential.

At the top of her list and her largest energy holding is Chevron (NYSE: CVX). “The catalyst is they’ve invested tens of billions of dollars in LNG projects in the Wheatstone and Gorgon projects in Australia, which will be coming on over the next couple of years. We’re excited about that.”

These LNG projects distinguish them from peers, she says, and will escalate production from flat to low double digits in 2015. “Asia is sucking up energy around the world,” she notes, particularly Japan, since the Fukushima disaster in 2011, and China, which wants to reduce smog from coal power generation and can’t add nuclear in a timely fashion. China will be Chevron’s biggest LNG customer, she thinks.

“Chevron had the foresight to see this would be an important role it could play because it had the dollars and the vision. Chevron should be in a sweet spot in 2015 and accelerate going forward.”

International oilfield services provider Baker Hughes (NYSE: BHI) is TCW’s second-highest energy investment. Jaffee labels the company as “amazing.” It has joined the Big 3 of Schlumberger (NYSE: SLB) and Halliburton (NYSE: HAL) following an integration with BJ Services and reoriented internationally.

“The company’s international division has a lot of upside potential in terms of increased operating margins with new efficiencies,” she says.

Earnings remain subpar due to a longer integration than anticipated, but new markets and new products across its international footprint, aggressive cost cutting and restructuring, and new management from a rival will act as catalysts to move the stock upward.

“Even if oil and gas prices wobble,” Jaffee says, “you’re going to need these service companies.”

On the downstream side, she puts her confidence in Valero (NYSE: VLO). Chief executive Bill Klesse has done “an unbelievable job” restructuring the portfolio and integrating ethanol acquired below book value into the refined mix.

“He sold refineries when the market became difficult, and more recently he has bought refineries at rock-bottom prices from companies needing to divest. Upgrades done in the past 12 months should help the company be the low-cost refiner in the Gulf.”

Although E&Ps such as Anadarko Petroleum Corp. (NYSE: APC) and Whiting Petroleum once were steady holdings in TCW’s portfolio, most “flew out of the portfolio on the upside” as they reached their valuation targets, Jaffee says.

“We’re wary of traditional E&P gas companies, because while this winter was an unbelievable time to own some of these as natural gas prices have gone from sub $3 to more than $5, we believe the longer-term trend is in the range of $3 to $4.”

Similarly, she believes oil-weighted E&Ps have generally peaked. “Many are smaller and more expensive to buy,” she says, and “while we’re not calling for a big decline in oil prices, you would have to think there would be some pressure on them.”

The one exception for her is Denbury Resources Inc. (NYSE: DNR), a specialist in onshore enhanced oil recovery.

“Denbury has a unique situation in which it takes a noxious gas—carbon dioxide—and stimulates wells so they can produce long after many others thought they had run dry. It’s done a good job locking in its cost basis as well as focusing its portfolio. It is a differentiator in how it gets oil out of these older wells.”