Last updated: Mar-18-2019

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Veteran business journalist and investigative reporter Olev Edur takes you behind the performance numbers for close-up look at the people, processes, and portfolios that make investment funds tick.

By Olev Edur  | Wednesday, September 06, 2017

Natural resource funds have fared poorly over the past decade, as the global economy continues to recover from the monetary crisis and consequent recession. The Natural Resources Equity category as a whole has turned in an average annualized negative rate of return over the period. Some funds, of course, with able management, consistently buck the trend. One such is the FundGrade A+ Award-winning Fidelity Global Natural Resources Fund, which has managed to pull off category-beating positive returns over the same period.

The average annual compounded rate of return for Natural Resources Equity category for the 10-year period through July 31, 2017 was a miserable -5.1%. Still, there are signs of life in the sector – returns from resource funds averaged 1.6% in July, second only to the one-month return posted by the Greater China Equity category.

Darren Lekkerkerker and Joe Overdevest, co-managers of the Fidelity Global Natural Resources Fund, continue to choose commodities and companies with care, while keeping a close eye on the macro picture – a strategy that has consistently put them at the top of the performance listings for the category, with an average annual compounded rate of return of 3.2% over the past 10 years and 5.7% over the past five years, as at July 31.

“Commodities was the place to be during the period from 2003 to 2011,” says Lekkerkerker (who handles materials, while Overdevest handles energy stocks, in a 50/50 portfolio split). “The fundamentals were very attractive, but since then, performance has been mixed. There have been bull markets in some individual commodities, but for example, the period from 2013 through 2016 was particularly bad for mining stocks, both base metals and gold. Some companies fell more than 50%, although others doubled in value during the same period.”

“The supply and demand picture can vary quite dramatically for different commodities,” Lekkerkerker adds. “We favor zinc and copper; zinc because supply and demand is very tight, and copper because supplies are getting tighter and could move to a deficit in two or three years’ time – not many new mines are being created. We’re bullish on gold too, but cautious. Gold has positive portfolio characteristics – it goes up when other things go down – but we’re worried that rising interest rates could drive prices down.”

“Timber is up a lot because of growing demand from a strong U.S. housing market, as well as the current softwood lumber negotiations with Canada,” says Lekkerkerker. “We also have a big position in packaging companies, which have benefitted from the fall in commodity and oil prices.”

As for energy-related stocks, Overdevest notes that here too, performance can vary dramatically among players. “You have refiners, integrateds, services – they’re all different,” he says. “Overall, though, the outlook for the energy sector is not great, but it’s okay. Supply and demand are pretty well balanced now, and world growth is doing okay. The biggest change has been increased shale oil drilling in the U.S., which has led to lower costs. The production cost of oil from the tar sands is US$100 a barrel, but in Texas it now costs $45 a barrel, and that has driven down commodity prices.”

How to make sense of all these variations? “We have a bottom-up focus, but we also look at supply and demand for each individual commodity, as well as overall macro demand,” says Overdevest. “We’ll buy large, medium or small caps, both growth and value-oriented, and the way we choose is based on the answers to four questions:

1. Is the commodity attractive? What do supply and demand look like?

2. Is this a good business? Does it have a good competitive position, strong cash flow, and high return on investment?

3. Is the management team aligned with us? Have they done a good job in the past, and do they have the same goals as us, that will benefit our shareholders?

4. Is the valuation attractive? Sometimes good news has already been priced into stocks, other times it’s ignored.”

The strategy has led to picks like Toronto-based First Quantum Minerals Ltd. (TSX: FM). “This is a well-managed copper miner with high-quality assets, and they are building a new mine in Panama that will almost double their production and exponentially increase their profits, yet the stock price has not done very well,” says Lekkerkerker. “They’re up just 2% on the year to date, versus 12% up to as much as 45% for its peers.

Another favorite is Dallas, Texas-based Texas Pacific Land Trust (NYSE: TPL). “The history behind this company is that when they were building the railroad in Texas, the builders were given land rights in perpetuity, including all drilling rights, and some of the lands were located right in the Permian Basin,” says Overdevest. “Now they receive royalties in perpetuity but have no drilling or field costs. They’re just landowners, and have free cash flow of 3%-4%, with which they buy back stock and issue dividends.”

Olev Edur is an experienced financial and business journalist and a frequent contributor to the Fund Library.

Notes and Disclaimers

© 2017 by Fund Library. All rights reserved. Reproduction in whole or in part by any means without written permission is prohibited.

Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the simplified prospectus before investing. Mutual funds are not guaranteed and are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer. There can be no assurances that the fund will be able to maintain its net asset value per security at a constant amount or that the full amount of your investment in the fund will be returned to you. Fund values change frequently and past performance may not be repeated. No guarantee of performance is made or implied. The foregoing is for general information purposes only. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.

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