Gold mining stocks could be set for an unprecedented spike in performance, according to FE Alpha Manager Iain Stewart (pictured), who says his overweight position in the precious metal is finally paying off.

The manager’s 6.5 per cent exposure to gold equities has been a major drag on performance in the last 18 months or so, thanks largely to rising costs and environmental regulations, as well as their high correlation to markets. 

However, Stewart expects these companies to build on their strong run since the Federal Reserve's announcement of QE3, and could close the gap on the gold price before long. 

"We felt there would be more stimulus, but we were a little surprised that the Fed decided to do another round so close to the election," said Stewart, who heads up the £6.3bn Newton Real Return fund. 

"The fact that authorities now seem wedded to the unorthodox policy of printing money supports the long-term case for holding gold in a portfolio – particularly as the Fed’s measures are essentially unlimited." 

Stewart says it is not just the rising price of bullion that has aided the performance of gold equities, however. 

He commented: "We try to look at fundamentals and a lot of things have gone in favour of gold equities of late. A lot of what has gone wrong for miners in recent months is on the cost side, and these pressures seem to be coming off a bit." 

"Our gold equity exposure has been a big drag on performance; the year to the end of August, our position extracted 20 basis points’ worth of returns." 

"However, it was our best performer in September and could perform incredibly well if fundamentals continue to improve." 

"It is very under-owned by investors and remains a good inflation hedge in our portfolio – if not a core position." 

Stewart’s Real Return fund has a 10 per cent position in gold overall – 3.5 per cent in gold ETFs and 6.5 per cent in gold equities. Australian gold mining company Newcrest Mining is among his top-10 holdings. 

Gold funds have had a tough time of late, with all seven in the IMA universe down between 12 and 59 per cent over the last 18 months.

The funds have recovered to varying degrees over the past month, with the two best performers over the period – BlackRock Gold & General and Investec Global Gold – up 13.04 and 11.5 per cent respectively. 

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Performance of funds over 18-months

 

Source: FE Analytics

Stewart remains cautiously positioned at present, holding more than 20 per cent of his assets in cash. His 45 per cent equity exposure remains defensively focused, with particularly strong positions in pharmaceuticals and utilities.

His biggest cyclical position is in oil & gas, which has an overall weighting of 4.5 per cent in the fund. 

"This has been the weakest area of the portfolio," he said. "We have big positions in multi-nationals like Petrobras and Total, which we felt had models suitable for a real return mandate." 

"We are not anti-cyclicals, but our exposure would have to be in reliable, stable companies." 

Most of Stewart’s 20 per cent corporate bond weighting is in B to BBB rated securities and he has a further 13 per cent in government bonds. However, he says record low yields are making it more and more difficult to find value. 

"This is why we hold a lot in cash," he explained. "It’s expensive to hedge and bond yields are low and not risk free." 

Performance of fund vs sector and index

Name	6-month returns (%)	1-yr returns (%)	3-yr returns (%)	5-yr returns (%)	10-yr returns (%)
Newton Real Return	5.85	9.58	19.78	37.19	174.93
IMA Absolute Return	1.08	3.05	5.89	11.45	N/A
LIBOR GBP 1m	0.3	0.68	1.85	9.64	38.06

Source: FE Analytics

Despite gold equities’ drag on performance, Newton Real Return has outperformed both its IMA Absolute Return sector average and Libor GBP 1month benchmark over one-, three- and five-year periods, as well as over six months. It has been more volatile, however. 

The fund has the longest track record of any in its sector. It has managed to at least break even in eight of the last nine years – the exception being in 2011, when it lost 0.75 per cent. 

The fund has a minimum investment of £1,000 and a total expense ratio (TER) of 1.61 per cent.