What is the underlying strategy behind the management of the fund?
The First State Global Resources Fund is actively managed using a fundamental, bottom-up stock selection process. Key to the investment decision is the quality of a company and an analysis of the quality of the underlying assets, rather than a short-term commodity price view. Valuation is also important; in addition to the company’s historical valuation range we also focus upon relative valuation to peers and across the value chain. By focusing on companies that are growing their earnings, with robust balance sheets and costs in the lower half of the cost curve we aim to deliver good returns over the full commodity price cycle without taking on excessive risk. We also look for the most promising early stage exploration and development companies that can create value through discovery and development. The best of the junior explorers and developers become the M&A targets for the mid-range and senior companies and can be meaningful contributors to the Fund’s performance.
What benefits do global resource funds bring to a balanced portfolio?
Longer term both the mining and energy sectors have delivered strong total returns, especially in periods where global growth is improving. Management’s renewed focus on capital discipline has seen the sector’s free cash flow improve significantly as capital expenditure and costs are reduced. Rather than pursuing growth opportunities many companies are electing to: reduce discretionary spending on exploration; sell non-core assets; pay down debt; and return cash to shareholders via dividends. This should downside protection for valuations after the lengthiest period of underperformance since 1985.
What sectors do the fund currently favour?
The portfolio is overweight copper where we continue to like the long term fundamentals and can find a good range of quality companies with stock specific catalysts. We will continue to add to these positions on weakness. The portfolio remains underweight gold, where we adopt a bar-bell approach, holding both the highest quality large cap names like Goldcorp and Franco Nevada and emerging producers like Detour and Torex.
How do you foresee the sector weightings changing over the next twelve months?
We have been reducing the Fund’s overweight energy position, as relative valuations in the mining sector have improved. This is likely to continue if we see sustained improvements in free cash flow and capital allocation from the miners. In energy we have a preference for oil exploration and production companies, especially onshore US oil, ahead of European integrated companies.
What will be the main challenges facing global resources over the coming years?
The valuation of the resources sector remains attractive, although deteriorating expectations of activity in China are providing a headwind for the shares. We do expect growth rates will moderate, but demand is coming from a very high base and intensity of metals use is still well below developed countries. After a period of aggressive capital spending mining companies have reined in capex and aligned themselves more closely with investors. It will be challenging for the miners to meet investor expectations for capital restraint whilst at the same time maintaining or increasing production to meet growing demand for resources. If so this should be supportive of future commodity prices.