A growing number of equity income managers have been buying back into Rio Tinto and BHP Billiton in recent months as the companies become more focused on returning cash to shareholders after a period of over-expansion and poor share price performance. Managers who have been buying mining stocks for their funds point to the fact that new management teams have been put in place which are reeling in capital expenditure and focusing more on rewarding shareholders.
However Clark, who manages the five crown-rated Fidelity Moneybuilder Dividend fund, says that while taking this contrarian approach may be appropriate for growth investors, the uncertain economic outlook means that mining companies’ dividends may be at risk in the future.
“Miners have historically, prior to the boom years, been very much dividend-paying stocks,” he said. “They used to be very cash-generative businesses and I’m aware of the fact that new management teams have come in and are attempting to make them old school mining companies.”
“However, looking at it from an income perspective, the problem is that these companies mainly focus on iron ore production and they basically have one major customer, which is China. If the slowdown continues, then I think their price is at risk,” he said.
According to FE Analytics, the MSCI AC World Metal & Mining index has lost more than 40 per cent over the past three years while the general MSCI AC World index has returned more than 20 per cent.
Performance of indices over 3yrs
Source: FE Analytics
The economic slowdown in China has been one of the most prominent headwinds investors have had to face over the past few years and has been a key driver of the sector’s underperformance.
Many industry experts, such as Psigma’s Tom Becket, say investors should expect this trend to continue as the Chinese authorities attempt to shift their economy from an investment led model to a consumption-driven one.
They say this change will take time and as a result investors should realise that volatility is likely to be prominent for some time to come.
Clark says that in the current environment of ultra-low interest rates and steadily rising bond yields, the reliability of companies dividends is the most important consideration for equity income investors.
He says that if investors are looking for a regular and reliable dividend, the uncertain macroeconomic outlook means mining stocks are not the best place to invest in.
Clark is looking for other value income opportunities instead and, as a result, is buying bombed out oil stocks such as BP.
“Oil is different as it is not purely dependent on China. It is a difficult one, but I see more risk to my capital in mining stocks than oil stocks,” Clark said.
He isn’t alone in his bearishness over miners.
FE Alpha Manager Evy Hambro, whose BlackRock Gold & General fund focuses on the sector, says that the commodities cycle hasn’t turned yet and as a result investors who are buying back in now in the anticipation of an upswing could well be hit by further losses.
Clark has managed his £722m Fidelity Moneybuilder Dividend fund since July 2008.
Our data shows the fund is a top-quartile performer in the IMA UK Equity Income sector over that time with returns of 68.36 per cent, beating its benchmark – the FTSE All Share – by 15 percentage points.
Performance of fund vs sector and index since July 2008
Source: FE Analytics
The fund has not rallied as strongly as its peers since the financial crash and as a result has only delivered third-quartile returns over five years.
However, it has an above-average yield of 4.16 per cent and FE Analytics data shows that Clark has been able to increase his net distribution in each of the last three years.
The fund has an ongoing charges figure (OCF) of 1.2 per cent and requires a minimum investment of £1,000.
Julian Chillingworth (pictured), has been buying FTSE 100 listed mining giants BHP Billiton and Rio Tinto for his Rathbone Blue Chip Income & Growth fund over the last year.
He agrees with Clark that equity income investors could have their fingers burnt if they look outside of the major mining names for value, but says there is no real risk associated with holding Rio and BHP for income.
“Our view is that below the top-tier miners, the sector may well be an unpredictable income play,” Chillingworth said.
“However, we have bought BHP Billiton and Rio Tinto as they are two of the world’s leading mining companies. They are displaying discipline over their capital expenditure and are very much focused on maintaining a steady income flow.”
“They also have a very good history of dividend payments,” he added.
Both those mining stocks have had new management teams put in place over the past few years, but they have also lost money over one and three years while the wider market has rallied.
Performance of stocks vs index over 3yrs
Source: FE Analytics
FE data shows that 34 out of a possible 96 funds in the IMA Equity Income sector count Rio Tinto as a top 10 holding – including Artemis Income – while 18 funds hold BHP Billiton in their top 10 – such as Liontrust Macro Equity Income.
Chillingworth also points out BHP and Rio are both world leaders for the extraction of premium iron ore, which is becoming popular in China.
“Yes, there is a difference between the mining companies, but both Rio and BHP are the major suppliers of iron ore to the world, not just China. They have also been the leading suppliers of premium iron ore and the Chinese authorities are putting pressure on companies to use it to crack down on pollution,” he said.
“It is around 10 to 15 per cent more expensive than regular iron and there is increasing demand for it,” he added.
