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A Spin Through the Natural Resources Sector

Resources funds offer diversification, but they should be used with caution.

Christopher J. Traulsen, CFA 3 May, 2007 | 12:48PM
The natural resources arena has been a lucrative place to invest over the past few years, but not universally so (and not, interestingly, as lucrative as continental European small/mid caps). After racking up much higher gains than energy funds in 2001 to 2003, gold funds have flipped and lagged energy over the past three years, due mostly to the slump in gold prices in 2004.

Broader is Better
The above is just a small suggestion of how difficult it is to predict commodity prices, and is why we think most investors are better off with a diversified resources fund that spreads its bets across different subsectors than a focused offering. If you do want to buy a pure gold fund or a pure energy fund, however, we strongly suggest it be viewed as a long-term holding that will enhance the diversification of your client’s portfolio and help hedge against inflation. Such funds should be used in moderation only and clients will need to be prepared to hold on through rough patches—precious metals funds have the highest standard deviation of any Morningstar category over the past three year, at a gut-wrenching 26% annualised.

Among more diversified offerings, JPM Natural Resources is hardly a secret, but it merits the attention it receives. Manager Ian Henderson is very experienced, and we like the fund’s spread across a variety of resources sub-sectors, including precious metals, energy, base metals, and diamonds. That diversification helped it in 2004, when gold tanked, and helps shield the fund from a downturn in any one area. On the flip side, Henderson favours small- and mid-caps, which are inherently more volatile than large caps. Moreover, the sheer quantity of money he’s running in this style appears to have forced him to alter his style: The number of equities held by the fund has increased from 155 in June 2004 to 260 at the end of 2006. That hasn’t harmed the fund materially to date, as far as we can tell—but it clearly could dilute the impact of Henderson’s best picks and as such, bears close watching.

Golden, but Pricey
For investors seeking gold exposure in a UK domiciled offering, Merrill Lynch Gold and General is fairly pure offering, with just a smattering of non gold-related shares in the portfolio. It also features an experienced manager in Graham Birch. Like all gold funds, this one is extremely volatile, but it has put that risk to good use, outperforming the vast majority of its Morningstar Precious Metals Category peers over the three-, five-, and ten-year periods. At 1.81%, however, its TER isn’t attractive, and we’d encourage Merrill to cut it.

One to Avoid
We can’t leave the natural resources sector without mentioning MFM iFunds ETF Commodity fund. The fund levies an AMC of 1.75% (it does not disclose a TER), which is far too high for an offering that essentially uses a computer to allocate assets across trackers. And that 1.75% doesn’t even include the fees of the underlying ETFs or other administrative costs. Caveat emptor, indeed. A version of this article previously appeared in Investment Adviser, Financial Times Ltd.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

About Author

Christopher J. Traulsen, CFA

Christopher J. Traulsen, CFA  is director of fund research, Europe and Asia, Morningstar.

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