There was no activity in either the Growth or Income portfolios during October. However, space in last month's column did not allow me to explain why I increased exposure to commodities in both portfolios during September.
To suggest that commodities are out of favour is perhaps an understatement. I cannot remember a sector being so unpopular. It is dogged by a variety of concerns including the outlook for global growth, China's slowing economy, the demand/supply disequilibrium and geopolitical forces in the Middle East and beyond becoming more influential. Some factors are well rehearsed - some less so.
Yet I suggest the worst of the bad news may be behind us. As overstretched companies, both large and small, disappear or restructure, the supply of certain commodities, such as some base metals, is beginning to tighten.
One also needs to be selective. The general gloom has thrown a blanket over the whole sector. Yet I suggest the outlook for copper is better than that for iron ore or coal; the outlook for oil and gas produced by the shale operators is better than that for the larger companies; the outlook for gold mining companies and certain 'soft' commodities is better than that for some, if not most, of the mining majors.
Meanwhile, the stimulus in China is yet to properly kick in while Europe at last looks to be stirring. And the longer-term positives, such as population growth and the largest urbanisation the world has ever seen, are still playing out.
But, above all, the sector's valuation is at a relative and absolute low. Bad news is baked into prices. And, particularly at this level, certain commodities can respond positively when the unexpected happens. For example, it is not impossible that Saudi Arabia scales back its oil production. Meanwhile, with geopolitical tensions rising in parts of the world, if there was conflict then commodities such as oil and gold would probably rise in price.
With these factors in mind, I have increased exposure to commodities and energy in September in both portfolios via City Natural Resources High Yield Trust (CYN) and via Ecofin Water & Power Opportunities (ECWO) in the Growth portfolio. Having covered them in previous columns, below is a brief update.
City Natural Resources
CYN boasts a sound long-term record relative to its sector, and looks well placed to capitalise on any improvement in sentiment towards the sector. Its focus on small- and mid-cap resource companies has negatively impacted performance on the way down, but should be a positive when things turn around - helped by gearing of around 20 per cent.
But perhaps there are two other key attractions. Its broad exposure to a range of commodities, both hard and soft, is a positive. Whereas other investment trusts usually focus more narrowly on specific commodities, CYN retains a better spread. I like its focus on the smaller resource companies, copper, gold and gold mining, agriculture and palm oil, and alternative energy.
Secondly, I suggest investors have overlooked the fact that CYN has around 30 per cent of assets invested in bonds - run by the well-respected Ian Francis, who also runs New City High Yield Trust (NCYF). As visitors to my website know, when bought CYN offered a 6.5 per cent yield and stood at a 15 per cent discount. The yield - based on a dividend of 5.6p - still comfortably exceeds 6 per cent at time of writing.
Indeed, revenue reserves of nearly one-and-a-half years, and current-year revenues that cover the dividend, offer the prospect of CYN perhaps being able to build upon its good track record of dividend growth, despite the difficult operating environment.
Finally, one should be aware that there has been a change of co-manager within the CYN team. The experienced Will Smith is moving on but, having recently caught up with the team, there is strength in depth with Keith Watson and Robert Crayfourd stepping up, while Ian Francis will remain in situ. Five CYN directors have shown confidence by buying more than 68,000 shares at an average price of around 90.5p.
Ecofin Water & Power Opportunities
Readers may remember from a previous column ('Finding Value 2', 7 November 2014) that ECWO is a split-capital trust that focuses on utilities, energy and alternative energy, and infrastructure projects.
Catching up with the managers recently, I was reminded that regulated and non-regulated utilities make up more than half of the NAV and the outlook looks good. Utility companies globally should be able to exercise more pricing power given the huge investment needed in infrastructure both to replace ageing plant because of past under-investment and to meet increased demand.
In the US, a benign interest rate environment, solid fundamentals, decent expected returns (8-10 per cent) and modest valuations (standing at 10-year averages) all bode well. However, there has been an increased focus on European integrated utility companies. This is especially the case where new management teams are investing in regulated assets, infrastructure and energy efficiency instead of the traditional thermal power assets, and increasing capex in regulated businesses, as both should have positive cash flow and dividend implications.
Given the managers' belief that sector valuations look attractive following its recent derating, and that growth in renewable energies should also resume, it is no surprise that there is now an increased weighting towards Europe.
Meanwhile, a key element of its energy exposure is Lonestar Resources, which is focused on shale oil and gas exploration from its 30,000 acres in Texas. This is not an exploration company - the reserves are proven. And yet it looks cheap relative to its peers, despite very favourable fundamentals and statistics. Ways are being explored to put this right and raise the profile, including a main board listing on the NYSE or Nasdaq exchanges.
All in all, ECWO is undervalued. It stands on a 20 per cent-plus discount and offers a near 6 per cent yield, supported by over a year's revenue reserves. A continuation vote in 2016, an experienced management team that has recently and significantly added to its holdings, and gearing of over 50 per cent, suggest ECWO is well placed to benefit from any improvement in sentiment both by way of NAV growth and narrowing of the discount.
Other portfolio changes
Other changes to both portfolios during September included the top-slicing of International Biotechnology Trust (IBT) after a tremendous run in the sector generally, and a significant narrowing of the discount since last adding to both portfolios in April 2014 when standing on 20 per cent-plus.
In addition, I sold the Income portfolio's holding of BlackRock Commodities Income (BRCI) when standing on a small premium, in part because I remain concerned about the ability of some of the large oil and mining companies to maintain their dividends in the current environment.
