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Why you should hold on to your commodities funds through the slowdown

17 December 2012

Experts say the recent drop in demand for natural resources does not detract from the sector’s strong long-term growth prospects.

By Thomas McMahon,

Reporter, FE Trustnet

Commodities funds still have an important role to play in investors' portfolios despite the threat posed to the sector by the Chinese slowdown, according to Jason Hollands, managing director of communications at Bestinvest.

ALT_TAGChinese demand has become critical to commodity markets and, as growth in the world’s second-largest economy has slowed, prices in the asset class have suffered.

However, Hollands says that the outlook for the sector is not as clear-cut as many think.

"Our view is that it’s quite finely balanced," he commented. "We subscribe to the view that China has been a major driver of commodity markets and we are nervous about this."

"On the other hand, stimulus measures in the US are very inflationary, so there are competing pressures there. But it does make sense to have an allocation within a balanced portfolio." 

"China’s slowdown will affect metals prices in particular, so we prefer commodity funds that are more broadly based and have the ability to go short as well." 

Hollands prefers Investec Enhanced Natural Resources, a £199.3m portfolio managed by FE Alpha Manager Bradley George.

"It has a flexible mandate so it’s not particularly focused on oil and gas or precious metals," Hollands said. 

The fund invests across a range of commodities, from precious metals to energy to agriculture, and uses short positions to hedge its exposure. 

Performance of fund vs benchmark since launch

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Source: FE Analytics

Data from FE Analytics shows that the fund has made 11.36 per cent since launch in May 2008, while its bespoke benchmark is up 1.41 per cent. 

It has achieved this with an annualised volatility of just 14.22 per cent, very low for a fund in this sector, and likely a consequence of its hedging positions.

One advantage of holding a commodities fund is that they are likely to outperform in the long-run, albeit with higher volatility. 

Investec Enhanced Natural Resources does not fit this profile, although the lower volatility may appeal to those who view the world economy as unstable. 

Some commentators point out that despite the slowdown in China, the developing world continues to grow faster than the West, necessitating the greater use of resources and providing a reason to be bullish on commodities.

Brian Dennehy, managing director of fundexpert.co.uk, said: "We doubt the commodity supercycle is over, the recent cyclical downturn being very predictable."

"A lot of the world is still growing, and demand [for commodities], from food to infrastructure materials, will begin to accelerate in the years ahead – keep an eye on India."

For those who think there is still long-term growth potential in commodities, there are opportunities in the closed-ended space to get in to the sector cheaply. 

The average commodities and natural resources fund is on a discount of 12.9 per cent, according to figures from the AIC. 

City Natural Resources High Yield, for example, is currently on a discount of 16.7 per cent, despite the fact that over the past decade it has made 515.96 per cent.

Performance of trust vs sector over 10-yrs

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Source: FE Analytics

Iain Scouller, investment analyst at Oriel Securities, says that the discounts in the sector may present a buying opportunity for those with the stomach for risk, although he recommends caution. 

"The issue is that if the mining companies come under more pressure, is that telling you that their business model is in trouble?" he said. 

"If people are happy with a relatively volatile asset class, then the weakness may be a buying opportunity." 

Scouller says that his preferred fund in the sector is trading on a premium of 1 per cent, the price inflated by the search for yield. 

BlackRock Commodities Income is currently yielding 4.97 per cent, according to data from FE Analytics, although in capital growth terms its performance has been practically flat over five years.

Data from FE Analytics shows it has returned 0.06 per cent over that period and is up 13.05 per cent over three years. 

Scouller said: "We did a switch from a couple of funds into it on discount grounds recently."

"I think it’s particularly the yield that is attracting people and they have a good team at BlackRock." 

"It’s seen strong dividend growth over the past two to three years."

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.