If you were think of buying mining or oil shares as a direct play on rising commodity prices, Joanne Warner has a word of advice: don't. She maintains that the volatility of commodity prices makes such a "coat-tails" strategy too risky for long-term investors.
"Investment decisions based primarily on a directional view of commodity prices introduce unnecessary risks into an already notoriously volatile sector," advises Dr Warner, head of global resources at First State Investments and manager of the First State Global Resources Fund. "We employ a conservative approach better suited to long-term investors by focusing on some of the world-class, low-cost global resources companies that are well placed to benefit from positive long-term trends in the sector."
Short-term cycles: risky and thankless
First State takes investment decisions based on a three- to five-year view. "Going through repeated short-term cycles of fear and greed is not only a risky and thankless task, but would also result in pandemonium," explains Ms Warner.
First State prefers to get under the surface of potential investments and really understand them. To achieve this, it has built a team of geologists, physicists, metallurgists and chemists who have made more than 950 site visits between them since the Global Resources Fund was launched in 2003. This way of investing requires a higher level of technical and scientific knowledge and involves a lot of groundwork, but Ms Warner believes it pays off. "Having been there and seen it provides real confidence in the buy decision," she says.
The performance of the Global Resources Fund bears out the success of this bottom-up approach. The fund has returned 30.1 per cent over the year to 30 November 2010, comfortably outperforming its benchmark over periods ranging from three months to three years, and is ranked in the first quartile since launch.
Joanne Warner
Resources cycle isn't over
"The demand for commodities is driven mostly by demographic trends, industrialisation and rising income levels in emerging markets," says Ms Warner. "The biggest growth occurs at low levels of GDP per capita, where populations are moving from the bicycle to the motorbike to the car."
"Global urbanisation is forecast to remain a strong driver of infrastructure development, which in turn will continue to support global demand for hard commodities." She explains that urbanisation isn't a new phenomenon: "A hundred years ago, 15 per cent of the global population lived in cities; that figure is now 50 per cent. What is now much higher, however, is the rate of urbanisation."
Ms Warner says miners have come through the economic crisis relatively unscathed, with recapitalised balance sheets and now strong free cash flows. "This puts them in a good position to acquire assets, many of which remain relatively undervalued," she explains.
Energy consumption also rising
As economies grow, so will their energy consumption. China and India are both net importers of energy and Ms Warner highlights the fact that China imports coal even though it is the world's largest producer. As the Chinese and Indian economies continue to urbanise, their energy consumption will grow even faster due to the impact of their large populations.
"China's per capita energy consumption is only around 25 per cent of that of western countries," says Ms Warner. She expects its growing middle class to aspire to car ownership, which is very low compared with western levels. With the benefit of new technology and new investment, Ms Warner hopes that China's energy consumption will be more efficient than that of already developed countries.
In addition to ongoing demand, Ms Warner says that natural resources investments are also bolstered by supply constraints, most notably a lack of high-quality major new projects, still-challenging debt markets and infrastructure bottlenecks.
| JOANNE WARNER CV |
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Dr Joanne Warner holds a PhD in solid state chemistry from Oxford University and joined First State in August 1997. Since November 2006, she has been the prime portfolio manager for all the publicly-offered global resources long funds in Australia, UK, Singapore and Hong Kong and became head of global resources in June 2010. Joanne has more than 15 years' experience as a specialist global resources portfolio manager and analyst. She moved into the financial sector with London-based global mining specialist broker T Hoare & Co, where she spent two years as an analyst before moving to Equitilink as a resources fund manager. |
Analysis always starts underground
Ms Warner describes the Global Resources Fund portfolio as built of some 10 "oak trees" (mostly major diversified miners), 20 "saplings" with advanced projects, and a big basket of around 40 earlier-stage "acorns". In each investment, the team looks for the potential to deliver long-term growth. "In many cases, it will depend on the ability of the company to capture opportunities arising from growing demand for commodities and improving efficiency in their production," she adds.
The fund strives for consistent diversification across many resources sectors and to own the very best names in each commodity. Given its bottom-up approach, the single most important criterion for potential investments is geology - analysis of opportunities always starts underground.
Oak trees offer good value
The fund's 10 largest holdings account for around half of the portfolio by weight and Ms Warner considers these "oak trees" - headed by Rio Tinto, BHP Billiton, Vale and Xstrata - to offer good value currently.
Ms Warner views copper as a structural story, with demand from urbanisation and industrialisation underpinned by declining average mined copper grades and a lagging supply response. "Cost inflation is also driving up long-term prices, despite the metal being near historic highs," she adds. The gold price is harder to forecast given that the only generator of demand is people wanting to buy. "It's all about sentiment," explains the manager.
In energy, the preference is for onshore oil and gas. The fund's exposure to North American gas - a trapped market - has decreased over the past three to four years. The fund has always had exposure to uranium, although it's not a large part of the portfolio.
The fund takes profits on sectors that have performed well and redeploys capital to areas with stronger growth prospects. It is more diligent in taking profits on smaller-cap holdings. Ms Warner explains: The only time you can actually sell small companies is when they are going up."
