Investment Trusts (2): And BlackRock Commodities Income Investment Trust

The first mutual fund (1774) was founded at Amsterdam's Stock Exchange, courtesy Wikipedia

 

The advantages of Investment Trusts as investment vehicles over Open Ended Investment Companies (OEICs) and Exchange Traded Funds (ETFs) are discussed in the previous article at http://thejoyfulinvestor.blogspot.co.uk/2014_03_01_archive.html

To resume, on average ITs perform better than ETFs and OEICs, as well as their benchmark indices, in nearly all equity markets. The one exception is the USA, where ITs perform about the same as ETFs and their benchmarks. It might surprise the sceptical investor, but fund managers, given the right structure, do perform better than their benchmarks.

John Baron is a former fund manager and author of the Financial Times' Guide to Investment Trusts (Pearson, 2013). Mr Baron runs two live, funded portfolios of investment trusts, which he publishes monthly in the Investors Chronicle. Both of his portfolios have handily outperformed their benchmarks over the past five years:

Return Jan 2009 to April 2014	Growth Portfolio	Income Portfolio
Mr Baron's portfolio	+130%	+108%
FTSE/WMA Private Investor Indices	+71%	+57%

 

His Growth Portfolio is currently 15% invested in bonds, 6% in commercial property, 1% in cash and 79% in equities. He uses 22 ITs and one ETF. The Income Portfolio has 36.5% invested in bonds, 9% in commercial property, 1% in cash and 53.5% in equities. The funds are invested in 19 ITs and two ETFs. He only uses ETFs for part of his bond holdings.

The annualised outperformance of 9.7% for the Growth Portfolio and 8.1% outperformance for the Income Portfolio compared to their benchmarks are exceptional. In part, this is due to Mr Baron's choice of ITs and in part to the underlying performance of the IT fund managers.

The main considerations for IT investing are covered in the previous article at http://thejoyfulinvestor.blogspot.co.uk/2014_03_01_archive.html

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BlackRock Commodities Income Investment Trust

 

Chino Copper Mine, New Mexico, courtesy Wikipedia

 

The worst performing Investment Trust (IT) sector over the last three years is commodities and natural resources. On average, this sector has lost 51% of its value in this time, according to Trustnet.

No IT sector presents a more contrarian theme than commodities and natural resources.

BlackRock Commodities Income Investment Trust (BRCI), capitalised at 108 million pounds, is the best performing IT in the commodities and natural resources category over one and three years (Trustnet). Mr Baron has included it in his income portfolio. The shares (in blue) and net asset value (in yellow) have comfortably beaten its benchmark (in red):

BRCI share price and NAV compared to the benchmark, courtesy Trustnet. Click to enlarge

 

The benchmark used by BRCI is the average of the MSCI indices on energy companies and commodity companies.

 

By investing in both the energy and mining sectors, BRCI has the flexibility to move its funds from one sector to the other. This gives it an advantage over ITs that are limited by their mandate to investing in either energy or mining.

 

At the end of February, about 40% of BRCI's funds were invested in ten companies. Seven are in the energy sector (BP, Canadian Oil Sands, Chevron, ENI, ExxonMobil, Royal Dutch Shell and Total) and three in mining (BHP Billiton, GlencoreXstrata and Rio Tinto). Geographically, 41% of the IT's assets are in companies with global operations, with another 40% in companies based in the USA and Canada. By sector, BRCI's assets are allocated as follows:

 

Sector (as at 28.02.2014)                 % of BRCI's Total Assets

Integrated Oil                                                      36.1

Diversified                                                           20.1

Exploration & Production                                 13.9

Copper                                                                 7.6

Gold                                                                      6.2

Oil Sands                                                              4.9

Iron Ore                                                               4.0

Oil Services                                                         3.3

Distribution                                                         2.8

Nickel                                                                   2.6

Coal                                                                       2.5

Fertilizers                                                             2.0

Aluminium                                                           1.5

Silver                                                                    1.2

Uranium                                                               1.1

Platinum                                                               0.5

Current liabilities                                                (10.3)

TOTAL                                                                   100.0

 

The fund's stated objective is "To achieve an annual dividend target and, over the long term, capital growth by investing primarily in securities of companies operating in the mining and energy sector." In practice, BRCI has increased the dividend by an average of 4% every year since its launch in 2005. At the present share price of 108p, BRCI yields 5.6%.

 

However, revenue earnings per share have remained static over this period. Base metal prices have fallen significantly in recent years and, consequently, earnings collapsed at the large mining companies. The ten-year chart of copper prices ($ per ton) illustrates the extreme volatility of metal prices in this period.

 

10-year copper prices, courtesy www.fastmarkets.com. Click to enlarge

 

The recent fall in metal prices is attributed to falling demand from China and to increased supply from mines that were opened to take advantage of the sharp increase in base metal prices in the 2000s. To add to this tale of mining woe, the dollar price of gold has fallen by 30% since its peak in 2011 and silver has fallen by 59% since it reached its peak in April 2011. The immediate outlook for mining is not good, but taking a longer view, the mismatch between demand and supply will work its way out, as it has in the past. In the meantime, the major mining companies are concentrating on cost reduction and cash conservation, which should improve profitability.

 

Oil prices were also very volatile until 2011, since when they have plateaud.

 

Brent Crude Oil price in $ per barrel, courtesy Money Week. Click to enlarge

 

The flattening of the oil price in the last three years is attributed to cheap gas from fracking in the USA counterbalanced by a determined effort by OPEC to keep prices high by limiting output.

 

The earnings of the oil majors, as a whole, have been hit by political, production and environmental problems that have more than countered the beneficial impact of high oil prices. While the immediate outlook is uncertain, in the longer term oil demand is expected to continue its long-term upward trend, which may sustain oil prices. Other externalities are unlikely to be so favourable. State owned oil companies have access to cheaper oil. The investment in difficult sources - tar sands, deep-water fields, the Arctic - can continue to cause production and environmental problems. And while oil companies might look to Iraq, Russia and Venezuela (with the highest proven reserves in the world) for growth, the former two are high risk and the government of Venezuela must first modify its rules for foreign companies. But it would be foolish to underestimate the managers of these companies and their know-how. Just consider how the industry has developed gas fracking or drilling for oil in the most inhospitable places.

 

Investing in this sector is a contrarian stance. For investors willing to take on this risk, BRCI offers a reasonable home. At the present price of 108p the shares trade at a discount of 1.8% to net asset value (NAV) and yield 5.6%. BlackRock manages the discount and premium, so its share price does not move far from NAV.

 

BRCI share price discount/premium. Graph courtesy Trustnet, click to enlarge.

 

If BRCI continues to increase its dividend payout by 4% a year, then at the current price this implies a 9.8% rate of return for the investor prior to any capital gains or losses.

 

The prospective investor will consider:

 

1.       BRCI has a revenue reserve of 3.1 million pounds with which to support its dividend payout.

2.       With 75% of its assets in non-sterling investments, mainly the US and Canadian dollars, there is a currency risk for UK investors. In one sense this is irrelevant, given that metal and oil prices are quoted in US dollars.

3.       BRCI has a new lead manager, Olivia Ker, who is an unknown quantity. Her assistant, Tom Holl, is ranked in the first quartile of fund managers for each of the last three years. However, BlackRock works as a team, and both managers are guided by the in-house team.

4.       Put and call options have been used by BRCI to bring in revenue. This is, however, an added source of risk. As is the use of debt, which amounts to 10% of gross assets.

5.       BlackRock charges 1.1% to manage the fund and it claims to have a total cost ratio of 1.4% for this fund. This is cheaper than a corresponding OEIC. No ETF offers an exact alternative for the UK investor. There are ETFs for 'broad basket' commodities, for just metals or just energy; and managers do make a difference. However, the Lyxor ETF Commodities CRB TRACKER (CRBL) is worth considering for investors wishing to use a cheap tracker. It claims a net expense ratio of 0.35%.

6.       Directors own shares in BRCI to the value of 250,000 pounds. BlackRock does not disclose the holdings of its fund managers.