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Going underground

The reining in of bank lending over the last few years has led to some interesting opportunities in unexpected areas. Before the financial crisis, banks happily lent to all and sundry at low interest rates, leveraging balance sheets to ridiculous levels. However, intent on rebuilding capital, banks are now taking the opposite attitude.

This dearth of lending has affected all kinds of sectors, and innovative fund managers with the right investment vehicles could be well placed to capitalise. One such sector is mining. Except for the biggest companies, it is seen as too high-risk for the newly cautious European banking sector. 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 does not have inflows and outflows of investor money like a unit trust or Oeic, so it allows the manager to explore more illiquid, higher-risk investments – such as mining company debt.

According to Hambro, the trust can use modest gearing to borrow at a cost of 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 is paid an annual 10 per cent coupon and receives 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.

Hambro diversifies the trust geographically as well as by commodity. Companies involved in the extraction of copper, iron ore and coal feature heavily, while nickel and zinc exposure is limited as 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 by 40 per cent so far this year and now below critical levels. He explains that China has been buying it all – to use rather than hoard or speculate.

An accusation many mining companies face is they reinvest cash in more capital-intensive projects rather than return it via dividends. This more risky strategy presupposes higher commodity prices or diminishing costs in the future, neither of which is a given. BHP Billiton, for example, is generating immense cashflow but reinvesting a big proportion of it. Hambro expects this to slow down, freeing up cash for dividends. If this happens, it could lead to a re-rating of the shares of BHP, as well as others in the sector which might be tempted to follow suit.

Another area 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 biggest net purchases of gold since 1964 and the bullion price was resilient. However, the share prices of gold miners fell. In his view, the catalyst to get them moving is a more positive attitude towards paying dividends, a recurring theme, it seems, in the mining sector.

From this point of view, it would not be surprising to see the trust’s own dividend rise as the underlying companies gradually introduce or increase payouts. The trust’s management fee is also changing so that 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 that manages a massive $40bn across all its funds, it could be an interesting addition to a high-risk portfolio.

Ben Yearsley is investment manager at Hargreaves Lansdown

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