Natural Resources Funds: We rate the five biggest

How do these natural resources behemoths differ, and which are the best? The Morningstar Sector Equity Natural Resources category is dominated by five key players in the retail space who have garnered the majority of these investors’ assets. Over the last few months we have met with the management of each of these funds to establish their Morningstar Qualitative Ratings.

Tom Whitelaw 02.11.2009
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The Morningstar Sector Equity Natural Resources category is dominated by five key players in the retail space who have garnered the majority of these investors’ assets. Over the last few months we have met with the management of each of these funds to establish their Morningstar Qualitative Ratings. Despite placing in the same category, the way in which each of these funds approaches the universe differs markedly. It is therefore important for investors to understand exactly what is on offer and, importantly, how much risk is being taken in each fund. This category is one of the equity market’s most volatile, with many unpredictable factors affecting the value of the commodities that make up the bulk of these funds—this emphasizes how critical it is for investors to take a long-term view w

hen investing in this sector.

So, let’s take a look at these five funds. By far the biggest fund in the category is BGF World Mining at around £6.7bn. Big isn’t always beautiful as bulk can prevent funds from navigating less liquid areas of the market efficiently, but this fund deservedly earns our Elite rating. The team behind this fund is one of the most stable and well resourced in the industry. Evy Hambro headlines the fund but the broader team is a key part of its appeal. The well-defined process incorporates their macro views, including potential political risk and, unlike some peers, they do extensive research on the ground and visit companies in situ. This isn't your typical resources fund: the portfolio is concentrated and is almost exclusively invested in metals and mining issues. This makes it more suitable for those who already have energy exposure through another vehicle or who wish to make a specific allocation to this part of the resources world, so it’s an unlikely contender for overall resources exposure. 2008 was a huge disappointment, to say the least – investors saw the fund lose over 50% of its value and fell over 15 percentage points more than the category average. But 2009 tells a better story and the fund is up nearly 70% to 22nd October, almost 25 percentage points better than the category. Key features: focused portfolio run by strong management team. Key risks: narrower focus than many resources funds; personnel critical to fund’s success.

In second place by asset size is JPMorgan Natural Resources at around £3bn. This fund also carries our Elite rating but it does have significant risks. In our opinion, Ian Henderson’s investment process is in the true spirit of resources investing. He is one of the sector’s longest-serving fund managers and his experience is paramount in making this fund the success that it is. Unlike his peers, he holds many of the industries’ smallest stocks, some of which have yet to even begin production. He balances these with liquid, large-cap holdings to keep risk in check and this results in a portfolio well in excess of 200 stocks –making it one of the broadest offerings in this space. But the exposure to small and mid caps mustn’t be underestimated – recently the fund had over 60% here, compared with 27% for the category average. In 2008 it lost investors over half of their assets - but year-to-date in 2009 Henderson is well on his way to recouping these losses with a return of nearly 88% to 22nd October. Key features: broad portfolio of well over 200 names with bias to mid and small-caps. Key risks: notable small-cap component including some highly speculative issues; personnel critical to fund's success.

The First State Global Resources fund, at number three and nearly £900m in the strategy, carries our Superior rating, a notch below Elite. It focuses on low cost producers and this gives some resilience when commodity prices fall thanks to the extra margins inherent in their operations. This focus on quality also means the fund steers clear of more speculative fare in the lower half of the cost curve and, unlike Ian Henderson at JPM, current physical production is a must here. The potential drawback to this approach is that the fund is unlikely to rise as fast as its more aggressive competitors in high growth environments. However the long-term average returns are promising and it has been less volatile than JPMorgan Natural Resources. The team behind this fund should also give investors a great deal of comfort. It has yet to see a departure and, although lead portfolio manager Joanne Warner has only officially been in charge since late 2006, she has worked alongside previous manager, David Whitten, for 12 years. Whitten now heads the group’s resources team. Key features: stable team, lower volatility than peers. Key risks: may not participate fully in up-markets.

At £577m, the Barings Global Resources fund sits much further up the market-cap ladder than the majority of its peers. At the end of June this year its average holding had a market cap of £16.4 bn. By way of comparison, JPMorgan had an average market cap of just £1.5 bn per holding. This large-cap bias should have helped the fund in 2008--larger caps held up better than mid and small names on a relative basis towards the end of the year as markets plunged. While the Barings fund lost less capital than JPMorgan Natural Resources, we would have expected the fund to hold up better than it did on a relative basis given its emphasis on risk control. Manager Jonathan Blake is convincing and without doubt he knows his companies well but in our opinion the risk controls in place don’t bring out the best in him or his process, as demonstrated last year. For this reason – and a TER at almost 2% - the fund is rated Standard, which means that while we don't think the fund is bad, we don't have conviction it can outperform going forward. Investors should also be aware of the potential for overlap with other holdings in their portfolios given the large-cap bias – for example, as at 31 Aug 2009 the fund held over 4.6% in BP, which is a mainstay in many UK equity funds. Another point to note is the share prices of the large multinationals tend not to be as closely correlated to the underlying commodity prices as smaller names so it’s not a pure play on commodities directly. Key feature: heavy large-cap bias can cut risk if implemented properly. Key risk: in our view, the risk controls here mute the manager’s potential.

Finally, at number five with £70m is Martin Currie GF Global Resources fund, which has earned our Superior rating. The Martin Currie team takes a much more diverse view of what constitutes natural resources. Rather than just restrict investments to energy, base metals and precious metals, the team extends their universe to 12 sub-sectors which include downstream processing, service providers, engineers and transport stocks. This allows much greater diversification across the business cycle and in theory makes it easier for the managers to outperform when traditional resources sectors are rolling over. It does mean the fund’s typical exposure to energy and industrial materials sits at around 80% compared with the average fund which is closer to 100%. This obviously impacts performance and in 2008 when many resources managers came unstuck, the diversification on show here enabled the fund managers to restrict losses. While the fund still fell over 23% it did outperform its average peer by an impressive 11.4 percentage points for the year. Nevertheless, just like other more risk-averse offerings the fund has struggled to keep pace with the rallying markets thus far in 2009. It is unlikely to suit those investors looking for a pure resources play, but the more cautious are likely to find favour from a fund with substantially lower volatility than the other peers cited here. Key feature: wide definition of resources adds some diversification. Key risk: performance could lag in up-markets.

That’s just a snapshot of five funds which reside in the same category--all approach natural resources investing in their own way. There’s no right or wrong way – it’s up to investors to decide which fund best suits their needs. Read our full qualitative research reports for more in-depth analysis, these are available at Some of the reports are in the final stage of publishing and will be available soon.
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