Somel (pictured), who took over from Graham French late last year, has increased his exposure from an all-time low of 12 per cent in November to 20 per cent at the time of writing, thanks largely to an enhanced position in BHP Billiton.M&G Global Basics held up to 50 per cent of its assets in miners in 2005, but worries over valuations prompted its management to slash this exposure from 2007.
Somel has decided to venture back into the unloved sector however, and is confident this will help turn around the performance of the fund, which has struggled in recent years.
“The price/book value of miners is one time, which is where it was in 2008 after markets fell off a cliff,” he explained.
Performance of indices over 10yrs
Source: FE Analytics
“Essentially you’re buying these companies at replacement cost, which is very attractive. At the end of 2010 mining was 5.5 per cent of the index and now it’s just 1.5 per cent. It is unloved by active managers and hugely under-owned.”
The MSCI AC World Metal and Mining index has a total market cap of £1.3trn, which Somel points out makes the sector just two and a half times the size of Apple.
While cheapness is always a positive for fund managers, buying something that is on a discount does not necessarily produce positive returns.
Somel says that the change in strategy from mining companies will be the catalyst for the turnaround in the sector.
“All of the company heads at the major miners – BHP Billiton, Rio Tinto, Glencore, Vale and so on – have changed recently, and they are delivering on what they are saying,” he explained.
“Capital discipline is at the forefront of their policy, and it is working. Something like BHP is yielding 4.5 per cent and dividends are only going to increase given plans for future curtailments.”
“For the very first time, BHP has written off assets, selling its diamonds and mineral sands industries. Finally these companies are less obsessed about growing and more focused on shareholders, which you can see from the increase in dividends and share buy-backs.”
Somel says the fact that global and even UK managers are upping their exposure to miners – including the likes of Ed Legget at Standard Life and Julie Dean at Cazenove – is further evidence of the changing sentiment towards the sector.
Although very short-term, the HSBC Global Mining index has made a good start to 2014 – up 5.11 per cent year-to-date compared with a slight loss from the MSCI AC World index.
The manager says that emerging markets are arguably even cheaper than miners, and will continue to back them in his fund.
“Equities perform best where there’s growth, and when the fund was launched in 2000 emerging markets were growing the fastest,” he said.
“Despite what you read, that is still very much the case now.”
“Emerging markets are the cheapest asset class by miles. The MSCI EM index is on a P/E of nine, which compares with 19 for the S&P. You look at the US and you have to say it’s overpriced – there are much better opportunities elsewhere.”
“For emerging markets and miners, nothing can go right. The divergence from the rest of the market is the highest I’ve ever seen, but they’re still the highest growth areas. For a long-term investor, that’s very attractive.”
Like his predecessor, Somel prefers to get exposure to emerging markets through more stable developed countries such as the US and Europe.
He currently only owns three stocks listed in emerging market countries.
“Strong balance sheets and good corporate governance is more associated with developed markets,” he said.
The strong run by the S&P in recent years has prompted Somel to move 20 percentage points underweight the US, however.
Europe is his favoured market, which he argues is significantly cheaper that the US and even the UK.
The manager’s M&G Managed Growth fund, which is predominantly a fund of funds, has recently upped its exposure to the M&G European and Pan European portfolio at the expense of M&G Global Basics.
Somel says concerns over the slowdown in China and other countries have been completely overdone, adding that the move from a manufacturing economy to a consumer-led one is not as immediate as many people suggest.
This, he says, will support a recovery in the mining sector.
“There are many people worrying about the slowdown in Chinese consumption of basic materials, but there isn’t one,” he explained.
“More than 50 per cent of China’s spending is on fixed assets. Yes it is moving away from that, but this will be very gradual. Even if this figure goes down, it doesn’t mean the spending isn’t growing – it just means it’s not growing as fast as other areas.”
“More than half of iron ore exports go into China, which continues to urbanise its population. Of all the iron ore produced in China, 40 per cent is domestically mined, which is of a much lower quality. The government is insisting that the use of domestic iron ore is cut down, which will only benefit the likes of BHP and Rio.”
The manager does hold some consumer-facing companies in his portfolio, but has cut his exposure to make way for mining due to elevated valuations.
He has sold out of top performers Colgate Palmolive and Fraser & Neave, for example, though remains very optimistic about the fortunes of Microsoft, which is also a top-10 position in his M&G Managed Growth portfolio.
He commented: “New research revealed that as many computers in China use Microsoft as the US, even though it only accounts for 5 per cent of the company’s profits compared with the US.”
“Why? Because of piracy. However, the rise of Microsoft Azure and cloud computing means that every user of Microsoft will have to log in, and will therefore have to pay.”
“Of course, not everyone in China will decide to pay but I have no doubt many will.”
“On top of that, Microsoft is a cheap share. It has a market cap of $300bn and has cash on the balance sheet of $85bn, with little debt.”
Somel also has a big position in Unilever, which he increased following the sell-off in the summer of last year.
The stock, which has around 60 per cent exposure to emerging markets, remains a favourite for a number of high-profile managers, including Finsbury Growth & Income's Nick Train.
The poor performance of mining and other industries closely associated with commodities and emerging markets has led to the fund’s own underperformance versus its peers in recent years.
FE data shows the fund has underperformed the IMA Global sector average and MSCI World index over one, three and five years, though remains ahead over 10.
Performance of fund, sector and index over 5yrs
Source: FE Analytics
The underperformance and general negative sentiment towards commodities has prompted significant outflows from the fund, with more than £1bn redeemed in the last 12 months alone.
Somel says he’s coping with the outflows with relative ease.
“I’ve been at M&G since 2005 and on the team of this particular fund since 2008. Over that time I’ve learned not only how to identify good companies, but also how to manage a portfolio day-to-day,” he said.
FE Trustnet will look at how investors can gain exposure to other funds in the mining sector in an article later on this week.
