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The safer way to cash in on a commodities rebound

26 September 2013

Ben Yearsley, head of investment research at Charles Stanley Direct, explains why he's drawn to the Investec Enhanced Natural Resources fund for his commodities exposure.

By Ben Yearsley,

Head of investment research

Commodities are an inherently risky place to put your money. They were one of the "must have" investments a decade ago, but have seemingly been in the "must avoid" category in the last few years.

Most commodities, especially industrial metals such as copper, appear intrinsically linked to the appetite of emerging markets; when China does well, commodities have performed strongly, when China wobbles, commodity prices and related share prices fall sharply. So, what are the prospects today?

ALT_TAG One thing that has not changed is that the quantity of natural resources in the world is finite. As the emerging world develops, more and more raw materials will be needed to build the infrastructure - roads, hospitals, airports and the other things we generally take for granted.

The developed world evolved over centuries but the emerging world is developing over decades, which I'm convinced will lead to pressures on the supply of key commodities at certain times - meaning the possibility of rising prices.

Today, many commodity prices are relatively depressed compared to prices a few years ago. The world waits to see whether Chinese growth will be 5, 6, or 7 per cent, or maybe more. In my opinion, many are missing the point.

It doesn't matter what the growth rate is, the important thing is that they are growing – and using more and more resources. Whilst supply might be seen as abundant today it doesn't mean it will be in five or 10 years' time.

If you subscribe to the view that commodities are in a temporary blip then for adventurous investors these lower prices could provide a buying opportunity. Yet for such a volatile, high risk area it could be worth considering a fund with one eye on protecting the downside – and in this regard the Investec Enhanced Natural Resources fund offers something a bit different to the typical fund investing in the area.

The 11-strong Investec team first form a view on all the key commodities by conducting supply and demand analysis. It is especially detailed on the demand side and they break it down precisely where a commodity is used.

Gold, for example, has industrial applications, as well as being used for jewelry and investment. They then predict whether a particular commodity will be in surplus or deficit helping them form an outlook on price. Interestingly, they believe company management of firms in the commodity sector is almost always too optimistic on the supply and demand balance.

Their outlook on raw materials prices then feeds through to the analysis of more than 300 commodity firms. As well as investing in the shares of these companies, the fund can also invest directly in the commodities themselves via Exchange Traded Commodities (ETCs) should the team feel it preferable. Typically, there will be 10 to 15 positions in these in addition to between 30 and 60 company holdings.

Unusually for a fund of this type, the managers can also take steps to reduce the volatility of the fund by "shorting" equities or the commodities themselves. This enables the fund to make money from falling prices – if they make the correct call and get their timing right.

It can also serve to dampen the volatility of the fund, though it is a complex procedure which can bring an additional element of risk. This year, as commodity company share prices have fallen out of favour, the strategy has been successful, and it explains the fund's strong outperformance compared to many of its peers.

Performance of funds and index in 2013

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Source: FE Analytics

However, if the fund shorts certain stocks or commodities in strongly rising markets it would likely underperform.

The ability to include some downside protection sets this fund apart from other natural resources funds, and for those adventurous investors seeking to invest in natural resources but to potentially reduce the inherent volatility it could be worth considering.

I have criticised this fund in the past for having an overly generous and inappropriate performance fee but I am pleased to say that Investec have announced the removal of this as of 4 October 2013. Once the fee is removed, the fund will be considered for inclusion on our recommended list.

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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.