Mining and commodity stocks have fallen dramatically over the past couple of years as the industry has been hit by falling demand in China and oversupply in the industry from management over-expansion.
Performance of indices over 2yrs
Source: FE Analytics
However, Cantor’s senior fund analyst Monica Tepes says there are signs the cycle could be turning, raising the possibility of huge gains in closed-ended funds that have slipped onto discounts.
“Just looking at the charts it does seem the underperformance has turned,” she said.
“We have heard a lot of managers over the last few months getting more and more positive on the sector.”
Tepes notes that FE Alpha Managers Julie Dean of the Cazenove UK Opportunities fund and Adrian Frost of the Artemis Income fund have both been buying back into the large cap miners Rio Tinto and BHP Billiton since last summer.
Data from FE Analytics shows that the mining sector on the UK market has actually outperformed in the year-to-date.
Performance of indices in 2014
Source: FE Analytics
One attraction of investment trusts is that they offer the opportunity to investors to play the discounts, and it is natural to look at such an out-of-favour sector for opportunities.
Tepes says her preferred trust in the area is the £872m BlackRock World Mining trust, managed by Evy Hambro and Catherine Raw. The trust is up 5.42 per cent in share price terms already this year.
However, the managers have been targeting a yield on the trust during the bad years for their sector, which has helped keep the discount down.
They buy mine royalties and use the income to provide investors a yield, currently at 4.3 per cent.
“BlackRock World Mining has been on a discount forever, but is now trading on a small premium to a discount,” Tepes said.
For this reason it may not be the best option for investors looking to play discounts.
“If you are waiting to get in on a discount and this is the turn of the cycle and there’s a bull market in natural resources companies, then it probably won’t be on a discount until it gets to the top,” Tepes said.
Manager Evy Hambro is highly regarded, however, and the trust is large and liquid, making it appealing to the retail investor.
Its top three holdings are the UK-linked miners Rio Tinto, Glencore Xstrata and BHP Billiton, while it also holds Brazilian mining giant Vale.
The manager outlined his expectations for the sector in a recent interview with FE Trustnet.
For investors who are looking to play the discounts, Tepes likes the £86m City Natural Resources High Yield trust.
The portfolio, managed by Ian Francis, Will Smith and Rob Crayfourd, is trading on a 20 per cent discount, according to AIC data, and has a healthy yield of 4.3 per cent.
The trust has 23.4 per cent in the bonds of energy companies.
In share price terms the trust has been badly hit over the past three years, losing 57.93 per cent.
Performance of trust vs sector over 3yrs
Source: FE Analytics
Nonetheless, Tepes suggests this trust could be one to take off if a bull market in commodities does ignite.
“It’s a smaller trust which invests in smaller companies so won’t hold the sort of companies that BlackRock World Mining does,” she said.
“If there’s a bull market it’s the large companies that attract the initial interest and then people will go into the smaller caps looking for where the value is.”
The trust’s largest holding is in REA Group, a palm oil producer with coal mines and a stone deposit in Indonesia.
Vermillion Energy is a Canadian oil company while New Britain Palm Oil is another palm oil producer. Palm oil can be used in the production of diesel as well as in cosmetics and food.
Another option for investors in the sector is the £20m New City Energy trust. Many investors prefer not to hold funds that small, however.
The fund is sitting on a discount of 12.2 per cent, and delivers an impressive 5.3 per cent yield.
The complication, Tepes explains, is that the managers have recently refashioned their portfolio to focus exclusively on shale oil and gas.
This means that although the oil and gas price will remain the chief driver of the fund’s performance, it would also be highly dependent on that particular subsector.
The fund’s top holding is Vermillion Energy, while it also has more than 5 per cent in PHX Energy Services and Canacol Energy.
The former produces drilling equipment while the latter is a diversified oil and gas company with both conventional and non-conventional wells. It operates largely in Colombia and Ecuador.
BlackRock World Mining has ongoing charges of 1.42 per cent. City Natural Resources High Yield charges 1.47 per cent and New City Energy charged 3.35 per cent last year inclusive of a performance fee.
