ENERGY LEVELS ON THE RISE
Portfolio Manager, BlackRock Commodities Income Investment Trust
Confidence is returning to the energy sector, says portfolio manager Olivia Markham, while mining may not have reached its peak.
Capital at risk: All financial investments involve an element of risk. Therefore, the value of your investment and any income from it will vary and your initial investment cannot be guaranteed. The BlackRock Commodities Income Investment Trust invests in the energy and mining sectors, aiming to achieve an annual dividend target and capital appreciation over the longer term. This longer-term view is important as both sectors can drift off the radar of generalist investors during rocky periods or downturns. In the case of energy, the Brent Crude Oil price has been through a slump over the past few years but, having risen above $70 per barrel in 2018 (Trading Economics), we believe that it has reached a point of relative price stability and it appears well supported at current levels.
As confidence grows that current oil prices are here to stay, the sector is well positioned to outperform broader stock markets over the medium term. We also believe that energy equities are attractively valued, which could translate into generous dividend yields. Past performance is not a reliable indicator of future results and should not be the sole factor of consideration when selecting a product or strategy.
Our view is that energy shares have not yet risen enough to reflect this oil-price strength. The Trust has therefore taken an overweight exposure to exploration and production companies, while also focusing on those energy companies offering attractive income streams. There is no guarantee that any forecasts will come to pass.
Global economic factors
We believe the outlook for global economic growth remains robust and we see this supporting healthy growth in the demand for oil over the next five years. Rising trade tensions are a key risk but for now we don’t see them derailing the current positive outlook.
Another risk to global growth in oil demand is renewable energy and the move towards electric vehicles in particular. However, we see this as a longer-term threat, on a 10 to 15-year view.
Meanwhile, in terms of oil supply, US shale oil production has not increased as fast as some had feared and OPEC continues to support the oil price with its production cap. We are also seeing general constraints on global oil production, resulting from reduced spending in the sector since the oil-price crash in mid-2014.
Like energy, mining had been out of favour following a torrid period from 2011 through to the end of 2015. Since then, however, we have seen vastly improved performance through 2016 and 2017 as commodity prices rebounded and mining companies reduced their debts. Our view is that we are still a long way below the 2011 peak and the sector continues to trade at a valuation discount to broader stock markets. Meanwhile, free cash flow in the sector is close to the highest it has ever been. Even so, many investors remain wary, expecting mining companies to make the same mistakes of the past in terms of poor capital discipline. Our view is that the pain of the recent down-cycle is still too fresh in the minds of management teams for this to become a widespread issue in the near term.
As with energy, we believe the mining sector offers a premium dividend yield compared with broader equity markets, as many of the big miners have switched to pay-out ratio dividend policies where dividends are based on earnings. We believe this is a sign of positive capital discipline and it gives us greater certainty around income when investing for the Trust.
Over the year to date (August 2018), the industrial commodities and mining equities have come under pressure due to fears of trade wars involving the US and China. However, in our view the recent falls in base metal prices look overdone relative to actual demand conditions, creating an attractive entry point to the sector.
There is no guarantee that any forecasts will come to pass.
Last, but not least, environmental, social and corporate governance (ESG) has become an increasingly important topic in the world of investment over the past few years. For us, investing in the energy and mining sectors, it is especially important that ESG considerations are embedded in our philosophy and process.
Our starting point is that we don’t make judgements about a company being a good or bad company just because of the business or sector it is in. Instead, we look for companies demonstrating the best ESG, as we believe it is positively correlated with investment performance.
When looking at mining companies, for example, their ability to maintain their social licence to operate is of critical importance. However, ESG is only one of many factors we look at and for a stock to be included in the portfolio the valuation and fundamentals also need to be right.
For more information on this Trust and how to access the opportunities presented by the commodities sector, please visit: www.blackrock.com/uk/brci All views expressed as at September 2018.
Overseas investment will be affected by movements in currency exchange rates. Emerging market investments are usually associated with higher investment risk than developed market investments. Therefore, the value of these investments may be unpredictable and subject to greater variation. Mining shares typically experience above- average volatility when compared to other investments. Trends which occur within the general equity market may not be mirrored within mining securities. Investment strategies, such as borrowing, used by the Trust can result in even larger losses suffered when the value of the underlying investments fall.