Ben Yearsley: High-risk, but BlackRock could prove a gold mine
Saturday 12 May 2012
The reining-in of bank lending over the last few years has led to some interesting opportunities in unexpected areas. Prior to the global financial crisis banks happily leant to all and sundry at low interest rates, leveraging balance sheets to ridiculouslevels. However, intent on rebuilding capital, banks are now taking the opposite attitude, refusing to lend on anything other than stringent terms to extremely well-capitalised companies for low-risk projects. This has affected all kinds of sectors, and innovative fund managers could be well placed to capitalise.
Take mining. Except for the largest companies it is too high risk for the newly cautious European banks. Starved of capital for expansion, smaller mining companies are looking elsewhere, and Evy Hambro, manager of the BlackRock World Mining Investment Trust, is one interested party. The advantage of an investment trust is that it has a "closed-ended" structure. This means it doesn't have inflows and outflows of investor money like a unit trust or open-ended investment company, so it allows the manager to explore more illiquid, higher-risk investments – such as mining company debt.
According to Mr Hambro, the trust can use modest gearing to borrow at about 2 per cent and then lend it out to commodity and mining companies at much higher rates: a classic "carry trade". He can frequently secure excellent terms with these more opportunistic debt securities and convertible bonds, which finance various activities such as the construction of gold mines. In one deal the trust receives a royalty on all future gold produced. In another, it is paid an annual 10 per cent coupon and received warrants to subscribe for the company's shares at a set price in the future. However, these opportunities remain at the periphery. The core of the trust is more conventionally invested in the ordinary shares of mining companies.
Mr Hambro diversifies the trust geographically as well as by commodity. Companies involved in the extraction of copper, iron ore and coal currently feature heavily, whilst nickel and zinc exposure is limited as Mr Hambro believes there is too much supply. He is also cautious on aluminium whose price he believes is susceptible to speculative trading. Copper is famously a good indicator of global economic activity, so it is interesting that inventories are down 40 per cent so far this year and now below critical levels. He explains China has been buying it all – to use rather than horde or speculate.
An accusation many mining companies face is they reinvest cash in more capital-intensive projects rather than return it via dividends. This riskier strategy presupposes higher commodity prices or diminishing costs in the future, neither of which are a given. BHP Billiton, for example, is generating immense cash flow but reinvesting a large proportion of it. Mr Hambro expects this to slow down freeing up cash for dividends. If this happens, it could lead to a re-rating of BHP's shares, as well as others in the sector who might follow suit.
Another area Mr Hambro favours is gold, and he is well known for his view that gold miners are materially undervalued. In 2011 central banks around the world made their largest net purchases of gold since 1964 and the bullion price was resilient. However, the shares of gold miners fell. In his view the catalyst to get them moving is a more positive attitude towards paying dividends.
From this point view it would not be surprising to see the trust's own dividend rise as the underlying companies gradually introduce or increase pay outs. The trust's management fee is also changing so it is primarily charged to capital rather than income. This should help to increase demand for the trust's shares. With a good-quality team at the helm who manage a massive, $40bn (£24.86bn) across all their funds, it could be an interesting addition to a high-risk portfolio.
Ben Yearsley is investment manager at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more details about the funds included in this column, visit www.h-l.co.uk/independent
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