The recent market correction shows that the many investors who piled into commodities stocks just as their price took a nosedive have failed to learn the lessons of the past
With the technology fund debacle still relatively fresh in the mind, it is astonishing to find investors making the same mistakes again so soon.
With a wearying inevitability, natural resources funds were the top sellers on FundsNetwork for the first quarter of 2006, just before commodity prices fell off a cliff in the recent stock market correction. It was a timely reminder that last year's top asset class is seldom this year's and investors would be better off taking a more creative approach to investing rather than just chasing top performers.
With this in mind, Fidelity recently issued a list of 'seven deadly investing sins'. Trying to time the market and being distracted by recent performance were the top two 'sins'. So those who invested in commodities funds because they believe that demand from China will create a long-term uptick in commodities prices could be forgiven.
Equally, those who believe that commodities are under-represented in their investment portfolios are also OK. Those who were simply investing because commodities have had a great three years are the sinners.
Also on Fidelity's list was investing without a long-term plan. Dabbling in different sectors of the market - commodities, technology, property - to chase performance can leave investors with a very disjointed portfolio, that has no great upside potential and does nothing to protect on the downside. It is the definition of 'seat of the pants' investing and makes for a nerve-wracking ride. So again, as long as the recent influx of investors into commodities were doing it with small chunks of their portfolio, while keeping the core of the portfolio in a diversified range of long-term, low-risk investments, that would be fine. Just investing because it is a hot topic, would not.
The other 'deadly sins' were focusing only on charges; duplicating investments; failing to review and trusting the future to cash. Too often, advisers have to sort out the portfolios of new clients who have committed all these 'sins' and it is a painful and expensive process.
But this is easy to say with hindsight. It is easy to get caught up in the excitement of a new investing 'story'. Will those who invested in commodities funds in the first quarter of this year lose their shirts? The picture is not clear. The outlook for commodities divides even the most seasoned market commentators.
In the 'for' camp is JPM Natural Resources manager Ian Henderson. He believes the sector still looks compelling. The problem of too much demand (from China) and lack of supply is not about to go away. The market is sensitive to every supply disruption, showing the delicate balance of the market. Equally, despite the fantastic performance of commodities stocks over the past year, there is still some apparent value. The UK-listed oil majors, for example, are trading at between 10 and 12 times earnings in most cases. Although this could be on peak earnings, it does not look expensive.
Sam Liddle, manager of the CF Miton Global portfolio, is also a long-term bull on the commodities market. He trimmed back his holdings prior to the recent stockmarket decline, but plans to buy back in as valuations drop.
In the 'anti' camp is Cazenove's Tim Russell, who has held a large underweight position in cyclical commodities stocks for some time to the detriment - until the past month - of his longer-term performance. He believes that commodities stocks are fundamentally over-valued.
Everyone knows that China is generating long-term demand for commodities and there is a supply squeeze so this is already reflected in the price of these stocks. And indeed, some stocks look very expensive. Cairn Energy, a stockmarket darling for many years, now trades on 91.9 times earnings. There are plenty of commodities stocks trading at between 30 and 35 times earnings. Russell argues that these are peak earnings so valuations are even higher than they appear.
With two great fund managers holding opposing views, it is hardly surprising retail investors are confused. The longer-term drivers are even more difficult to fathom. For example, if oil is finite, then surely its price is likely to go up and up until alternative energy sources come into day-to-day use? This would suggest that it is worth having exposure.
The answer is that probably both managers are right. There are elements of value within the commodities sector - particularly after the recent falls - but after three years of top performance they are thinner on the ground. There is a long-term bull case for commodities, but the chances of these funds being the top performers again this year or next year is very thin indeed. Within the boundaries of the Fidelity investing 'sins', buying into a commodities fund is a valid and rational way to enhance portfolio returns. But those who are only chasing performance could be sorely disappointed.
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