This sector is flying, but fund managers are not buying. We take a look at whether investment trusts are an indirect way to play the sector.
Which FTSE 100 sector has been the best performer over the 12 months to end September 2017? The mining sector must be right up there, with Chilean copper miner Antofagasta gaining 81 per cent and Glencore 61 per cent. The FTSE 100 was up 7 per cent. Anglo American and Rio Tinto are comparative laggards with gains of 38 and 34 per cent respectively. The latter threw in a dividend yield of close to 7 per cent on its share price a year ago for good measure.
So are these stocks now expensive? Not necessarily so: at a price of £35.85 Rio trades at an historic price/earnings ratio of 11.2 times and offers a yield of 5 per cent. Its gross cash flow yield (after capex but before interest and tax) is close to a 14 per cent return on enterprise value, compared to an 11-year average of around 9 per cent.
And yet, on the whole, the big retail fund managers – and particularly value-oriented ones – are underweight the sector or don’t own mining stocks. Neil Woodford – who has had well-publicised issues recently with the poor recent performance of the £9.3 billion CF Woodford Equity Income fund – has virtually nothing in basic materials (of which miners are a subset) compared to a weighting of 7.6 per cent in the FTSE All-Share index. His pupil and successor as head of UK equities at Invesco Perpetual, Mark Barnett, is similarly underweight in the £5.2 billion Invesco Perpetual Income fund.
This positioning seems, in part at least, based on a suspicion of all things Chinese, whose economy is the main driver of commodity demand. It may of course be correct to assume that China will suffer some sort of economic hard landing as its debt pile becomes unsustainable. But, if the authorities manage to muddle through, the Chinese economy is now so big that even if growth rates fall back considerably from current (stated) levels, the impact on global growth will still be significant.
What is more, levels of growth elsewhere appear to be picking up: Mark Carney, governor of the Bank of England, recently referred to a ‘strengthening and broadening global expansion’. The cynics would say, yes, but wait until the quantitative easing taps are turned off and then we will see.
Be that as it may, despite the strong performance over one year, the latest investment trust statistics from the Association of Investment Companies still show that the commodities and natural resources sector is the only one with a negative net asset value return over five years. This does reflect the China-induced euphoria that was prevalent in 2011/12, so it is a bit misleading. But it does show a sector that is still substantially out of favour; if we can buy underlying stocks which are not on demanding valuations at reasonable discounts, this ought to get our attention.
The sector is dominated by the big daddy, BlackRock World Mining (BRWM), with assets of £895 million; other larger trusts are its smaller sibling BlackRock Commodities Income (BRCI) and City Natural Resources High Yield (CYN). The latter is a bit too highly geared for our taste; and the portfolio is somewhat less ‘mainstream’.
BRWM hit a high of 800p in 2011 but now is less than half that price; it is on a discount of 11.3 per cent and has a prospective yield of more than 4 per cent. BRCI reached a high of 189p in 2008; but is now 60 per cent below that level. The discount is lower than for BRWM, possibly reflecting the higher yield, at well over 5 per cent. It is worth noting that these dividends, which were cut in 2016 after commodity prices collapsed, should be sustainable, at least for the next few years, as mining companies increase their cash flow and restore dividends.
We are not suggesting that these trusts can regain their previous heights; but with good yields and the potential for hedging against inflation, they should be considered for a small allocation of an investment portfolio. The two companies share some common holdings; the main difference is the exposure to oil & gas in BRCI.
A different, more indirect way to play the sector – and with a much greater oil & gas orientation, as well as more diversification – is Middlefield Canadian Income (MCT). This trust gives income-oriented exposure principally to the Canadian economy, which itself is influenced by the resources sector; but it also can hold some US companies. The trust is on a 9 per cent discount and yields 5 per cent. The latest survey of Canadian manufacturing from IHS Markit (for September) ‘signalled a robust improvement in manufacturing business conditions, although the strength of the recovery remained slightly softer than April’s six-year peak.’
Overall, the resources sector is certainly not the contrarian play it was a year ago; but it is still not as loved as it might be. Investors searching for yield may yet have to hunt here.
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