At Investors Chronicle, we think City Natural Resources High Yield Investment Trust is one of the best ways of getting diversified actively managed exposure to commodities. We tipped it when Richard Lockwood was at the helm (Read our tip here). Now that he is taking a back seat, we went to interview his successor as lead portfolio manager, Will Smith, who took the reins in October 2010.
The portfolio hasn't changed much since Mr Lockwood stepped down. The fund still has a big gold holding, accounting for 35 per cent of the portfolio. While Mr Smith says that will change at some point he has three specific criteria that will lead to a reduction in gold exposure: 1) a return to real interest rates, 2) a return to traditional growth in OECD countries, and 3) a credible solution to sovereign debt issues. "Then the need to have gold will be lessened," he says.
In the meantime, I ask him to pick a commodity for the next six months. Gold equities remain his choice. "Gold equities have underperformed the gold price but exchange-traded funds investing in physical gold can't provide dividends. Gold mining companies are getting the message about dividends.
"With gold trading at $1750 or $1650 an ounce - you've got to be incompetent as a gold miner not to have a $1000 margin on that. This will translate into share price performance. Some of the companies, for example Gold Corp and Eldorado Gold Corporation, will get the message that they've got to differentiate.
"But even if the gold price does nothing for the next six months, gold equities are still in great shape."
He points out that there has been a bull market in gold since 2003, since "Brown's bottom", referring to the point at which the then Chancellor of the Exchequer, Gordon Brown, sold half of Britain's gold reserves at the bottom of the price curve.
"Only this year will global gold production beat the previous high of 2001," he says. But he also points out that one graph relating to gold will never change, and that is the average grade of gold mined - it keeps going down and is now close to 1.5 grams, on average, per tonne of ore. "That's an awful lot of work for not much gold," he says. Lower ore grades require a miner to chew through more rock to recover the gold.
With its focus on gold miners, the fund is often seen as a complement to the widely held - and more diverse - BlackRock Gold and General fund. Mr Smith is happy with this comparison. But he says: "We will always seek out growth companies and we are smaller than the BlackRock fund." While the BlackRock fund is £3.3 billion, City Natural Resources High Yield is £250 million. The smaller fund has also performed better, over five-, three- and one-year periods.
While the City Natural Resources' yield is low for a trust that has High Yield in its name, this is a result of strong growth in the portfolio as the managers continue to increase the dividend. "If the NAV continues to run away I'm not going to apologise," says Mr Smith. The trust is trading at a 13.5 per cent discount to NAV as at 28 November, making it attractively priced.
Apart from gold, the fund invests in a broad portfolio of mining and resource equities, resources and industrial fixed interest securities, totalling over 180 holdings.
"We are believers in a secular bull market for commodities but not in a straight line," says Mr Smith. "Sentiment is pretty low in the market right now, so it was no surprise that October was a strong month."
"Without doubt there is a consumerist movement in China and India and it won't be reversed. Just look at the energy consumption of India and China and it is clear that resources will be in demand for a long period of time."
But although he says the world won't run out of minerals, the supply side of resources is very challenged. "There is no shortage of iron ore in Africa but building a mine is very expensive," he says.
There are also plenty of political risks to contend with, when seeking out mines to invest in. "We have got to work a little harder than take management's word for it that it is great," he says. "By meeting companies and by going out there we get a feel for the situation." The fund holds 30-35 meetings a week with companies.
For example, Mauritania has suffered from military coups but Mr Smith says it is still "a terrific country" in which to mine. "You can dig without disturbing the population and the environment," he says. "Plus, governments have always honoured the fiscal regimes to make the tax regimes stable. We had three companies there last year and they've all been taken over."
Places the fund doesn't invest include Venezuela and Kyrgyzstan. "If it is too risky for the Russians it is too risky for us," he says. Canada, on the other hand, is one of the best places to invest.
"There are endless political risks that we face. For example, no-one saw the Arab spring coming," he says. "The only way for investors to manage these risks is diversification. So the investment trust is the way to do it as the portfolio approach makes a lot of sense."