Many investors have turned their attention to growth opportunities in emerging market portfolios, including China and India, and a driving factor behind these markets in the long term is the impact that their growth is having on world resources.
Barclays Capital head of asset allocation Tim Bond says rising income levels in the developing world have fuelled a significant increase in global demand for natural resources but supply has not kept pace with demand, due largely to scarcity issues as well as under-investment.
News reports suggest that commodities are becoming increasingly scarce while energy demands continue to rise. Water may even be the source of the next major natural resource crisis as a growing desire for safer and more plentiful supplies is putting pressure on existing resources while climate change may be reducing the availability of fresh water.
Bond says: “Scarcity is forming across a wide range of resources, largely but not solely due to depletion.”
The energy sector alone is anticipated to need a major increase in the share of global fixed investmentif supply is to keep pacewith demand. Bond says: “Agricultural production, mining, waste disposal, fresh water exploitation, CO2 emission sequestering and resource recycling are areas where capacity additions are urgently needed.”
Rising investment returns in these sectors are the likely mechanism for capital to be directed to the necessary areas but Bond says capital requirements in the natural resources sectors are so big that returns in less essential market areas may suffer.
This logic dictates that portfolios should devote a large proportion of assets to the natural resources sector. Bond says adding such allocations does not just imply big weightings in commodities and commodity-producing firms but also encompasses the technological shifts and changing consumption patterns that will be affected by this broad trend.
Attention to this trendcan be identified already ina number of aspects in the UK fund industry. There has been the obvious move by fund managers to play the demand side of this trendby buying companies which they believe will benefit from the scarcity in natural resources. Just look at the recent popularity of the mining sector in mostUK equity portfolios.
Alliance Trust global oil and natural resources analyst Angus McPhail believes rising demand from Asian economies and a continuing global tightness of supply will result in another strong year for the mining sector.
He says: “The appetite of India and China for core commodities shows no sign of abating. Bulk commodities will continue to do well, particularly Australian coal and iron ore producers, which supply China. Gold is expected to remain strong but this is very dependent on continued weakness in the dollar and continuing concern about the fallout from the sub-prime crisis. Diamonds, like gold, offer a safe haven to preserve value in uncertain times. Demand for automobile catalystsin the US also means that platinum will do well.”
On the other side of this trend has been the launch of funds aimed at capturing the longer-term trends brought on by the increased demand for resources, from emerging market, agriculture and environmental funds to climate change portfolios.
Highlighting the rationale behind these moves is the fact that 47 of the top 50 units trusts/Oeics in the entire UK onshore industry over one year to February 20 are resource-based or exposed to emerging markets. It is interesting that 40 of these top 47 have a three-year track record, showing that older vehicles, rather than just new concept funds, are making strong gains.
In the specialist sector, 19 of the top 20 performers over the past year are resource-biased funds or emerging market portfolios and again it appears to be the older funds that dominate, with only six not having a three-year track record.
The broad resources sector will need an unprecedented share of investment. Bond says: “To attract the requisite share of capital, these areas will continue to offer above-average risk premia. Market bubbles, such as the 2007 mini-bubble in green and alternative energy stocks, are a side-effect of this process. They are a necessary evil, serving to flag the need for investment in a marketplace in which capital allocation decisions are still influenced disproportionately by momentum.”
Bond points out that economic growth over the past two decades has been punctured by regular crises, most of which have common elements – excess leverage and speculation – but this renewed trend of natural resource-based inflation may work to circumscribe the ability of central banks to cushion the blows from burst speculative bubbles in the future.
This means that in an industry known for jumping on bandwagons, green and climate change investments will hopefully have more substance than concept.