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Have commodities funds finally turned the corner?

The sector has rebounded after major losses in 2013, and FE Alpha Manager Bradley George expects it to continue performing well over the medium-term.

Alex Paget

By Alex Paget, Senior Reporter, FE Trus...
Thursday June 05, 2014

The outlook for natural resources funds is at its most positive for many years, according to Investec’s Bradley George, but he warns more confidence is needed for the sector to rally in a meaningful way. ALT_TAG

Following a period of very poor returns, commodity-focused funds have rebounded significantly since the start of the year.

George (pictured), manager of the £150m Investec Enhanced Natural Resources fund, says he is far more bullish than he was this time 12 months ago as he thinks the trend should continue.

However, he warns that the sector can only rally further if investors are confident that companies within the sector maintain their discipline.

“I am positive over the medium term. We have seen valuations increase from being extremely cheap, but the more generalist investor is still very underweight the sector,” George explained.

“I think the generalist investor will start to move out of the more expensive sectors, such as consumer staples, telcos, pharmas and financials and into commodities when more companies are able to demonstrate that they have the right mix of assets, are increasing volume growth and are effectively cutting costs.”

“I think that is when the big weight of money will come into the sector.”

Given the cyclical nature of the asset class, commodity funds have tended to perform when the global economy is strengthening.

In a recent FE Trustnet interview, Henderson’s Ben Lofthouse said that was is looking to increase his exposure to basic materials as it is a sector that has, in the past, thrived in a rising yield and interest rate environment.

George agrees that his fund – and others like it – should continue to deliver decent returns over the coming years. However, he says the major caveat to that is if companies revert back to their old habits of very ill-disciplined spending.

“It should be, but provided that there is confidence that commodity prices will hold and that companies will continue to demonstrate discipline with their capital,” he said.

“There has, however, been a marked change in the dividend pay-outs of commodity companies. They used to plough their money into projects but many management teams are saying that if a project doesn’t hit its hurdle rate, they will pay a dividend instead.”

Basic materials has been one of the most out-of-favour sectors over recent years with many managers shunning the sector following the collapse of the so-called “commodity super-cycle” in 2011.

According to FE Analytics, the average natural resources fund in the IMA universe has lost a hefty 25 per cent over the last three years. As a point of comparison, global equities – as shown by the MSCI AC World index – have returned close to 30 per cent over that time.

Performance of composite portfolio over 3yrs

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Source: FE Analytics



However, since the initial emerging market induced sell-off in January, commodity related funds have bounced back strongly and have – on average – returned close to 10 per cent. George says there have been various contributing factors which have caused the sector to spike.

“I am most certainly more positive than a year ago and there are a number of reasons why,” he said.

“Firstly, the demand side has actually picked up; especially in the US, where it has been much better than first anticipated. That is mainly because of the very cold winter, which has meant demand has increased for crude oil and heating products.”

“People are still worried about China, and while real estate has been weak, manufacturing and auto numbers have been very strong. It means that energy demand has been robust and while demand for commodities hasn’t been as strong, it’s not too bad overall.”

“Another difference from 12 months ago is that companies have been a lot more cost effective and that cost cutting has helped improve earnings. The final point is that certain companies, especially in the energy sector, have been rewarded for increasing volumes.”

However, George – who has the ability to take both long and short positions within his Investec Enhanced Natural Resources fund – says he is remaining very selective as he expects certain sub-sectors to vastly outperform in the current environment.

One of his largest bets is in the energy sector, particularly crude oil. One the other hand, George is underweight the metals and mining sector.

“Energy is a far more global sector and demand is much more diversified with the majority of demand coming from US, rather than just Asia. On the metals side, however, it is much more dependent on China,” he said.

Two of George’s largest holdings, the integrated energy companies Total and Suncor Energy, have returned more than 30 per cent over the last 12 months. The manager expects those types of stocks to continue to perform well as decline rates and supply-side issues should mean the price of crude oil should hold, or even increase, over the next few years.

He currently holds 20 per cent of his fund in the integrated oil and gas sector.

However, due to slowing growth in China and the country’s changing economic model, George expects the price of iron-ore to come under pressure and is therefore net short the metal within his fund.

George, along with his co-manager George Cheveley, launched the £150m Investec Enhanced Natural Resources fund in May 2008. According to FE Analytics, the fund has returned 5.25 per cent since inception.

As a point of comparison, the MSCI AC World Materials Index has lost 0.1 per cent over that time.


Performance of fund vs index since May 2008

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Source: FE Analytics


However, while the fund has protected investors more effectively than most over recent years, Investec Enhanced Natural Resources has failed to rebound as strongly as JPM Natural Resources and BlackRock Natural Resources Income & Growth in 2014.

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