Investec Enhanced Natural Resources managers Bradley George and George Cheveley are stockpiling cash and waiting for natural resources equity valuations to get even cheaper before reinvesting.

Looking to deploy 20% cash holding

The fund currently holds around 20% in cash and George told Citywire Selection he expected valuations in the natural resources sector to fall a little further.

‘With general equity investors sitting on the sidelines in the natural resources sector valuations might get a little bit cheaper and we have been using the cash as a buffer to lower volatility.’

Rather than being short parts of the natural resources market, the managers have preferred cash as they anticipate the market nearing the bottom. 

Citing the recent pick up in Chinese infrastructure activity in May as a positive sign, George expects better news from the core hard commodities market.

‘We are hoping to deploy that [cash] over the next month or two, as these valuations are really starting to screen extremely well’.

The managers are eyeing copper equities as they are already invested in the underlying metal but are waiting for the price to stabilise and signs of increased confidence in the market.

The two key prospective copper buys are Freeport McMoRan and First Quantum but with both these companies currently involved in corporate and M&A activities, the managers are waiting for these to settle before considering investing.

Another area they are watching closely is iron ore. The commodity’s price came under pressure around the start of the year and the managers are waiting for it to stabilise. They are looking to reinvest in this metal through Rio Tinto, a position they exited in January but which they now believe to be trading on an attractive valuation again.

Energy equities main investment prospects

George sees energy equities as the best opportunity within the natural resources space. Energy equities have remained flat and the underlying commodity equities and prices have underperformed over the last 18 months, whereas most equity markets have rallied by around 20-25%.

He admitted that energy had been a real underperformer but said it still looked strong. ‘Energy equities provide decent dividend yields, strong cash flow generation and return cash to shareholders who love quality and defensive stocks. These are the most defensive cyclical stocks’.

Playing this theme, the portfolio is invested in companies that have had a long life of threatened oil supply, a situation that will continue for a while. The key holdings are in Suncor (Canada), Chevron (USA), E&I (Europe), Anadarko (USA) and Noble energy amongst others.

The fund’s performance has been strong compared to the overall volatility in the resources market. The portfolio is highly correlated to energy with an overall exposure of 65%, energy alone accounts for 40%.

Positive on Crude oil

The fund has significant exposure to integrated oil and gas, crude oil E&P and oil services companies involved in the production of US onshore crude oil. Oil refineries that had halted production for maintenance in March and April are now using crude oil to produce gasoline and diesel as the weather is now improving in the US and Europe ahead of the main driving season.

‘Overall the oil market looks balanced and there is no need to cut production. We have confidence in crude prices and expect it to move higher this year to $110 and next year to around $115 per barrel.’

Platinum and palladium are the only commodities the fund has outright exposure to. The fund is currently positive on these physical commodities but negative on their equities with the sector currently undergoing a huge wage negotiation process in South Africa with a lot of tension due to trade union activity.

‘Production will be weak for these companies and earning volatile for the next few months so we don’t want to be exposed to equities and only have direct exposure, which increases pressure on the underlying commodity’.

The managers expect the situation to stabilise only by the beginning of next year. George said all major producers of platinum and palladium were being affected by the unrest, including Lonmin, Impala and Angloplat.

Since inception in May 2008 to 30^thApril 2013 the fund has beaten the Citywire Alternative Ucits average manager returning 7.25% compared to the benchmark’s -1.78%.

Citywire Selection Verdict: This fund aims to keep the volatility low and deliver consistent outperformance over the long term. It has returned 9.3% since inception in May 2008 while the FTSE AW/Oil & Gas index has returned 10.2% during the same period. In the recent difficult climate it has performed better than its peers and maintained lower volatility levels. The managers use long-short strategies to reduce the volatility to profit from overvalued areas of the market. The fund is currently backing energy equities, copper and iron ore companies. It has impressed in its relatively short life span and the lower drawdowns provide a steady return pattern for investors.