By Heather Connon –
Two of the best-performing investment sectors over the last five years or so have been commodities and income funds. Now Merrill Lynch has decided to combine the two with the launch of a commodity investment trust which will provide a decent income.
The Merrill Lynch Commodities Income Investment Trust is seeking to raise around £120 million from retail and institutional investors by the closing date of 6 December. It will aim to generate a yield of around 4.25 per cent, putting it towards the higher end of income funds. It will also have provisions to buy back its shares or call a vote to wind up the trust to prevent the share price falling to a big discount to the value of its underlying assets, something which can be an issue with investment trusts.
Technicalities apart, is it worth buying? Merrill Lynch has one of the best commodities teams around: its Gold and General unit trust and World Mining investment trusts have both risen more than 250 per cent over the last five years and Richard Davis, who will run the trust, has been part of the team managing these funds for more than 10 years.
While commodities have had a spectacular run, Davis believes there should be more growth to come. This is both because of the surge in demand from China and, increasingly, India as they become more industrialised and because ‘growth in the supply of metals and minerals is held back by a lack of investment and limited exploration success and in addition inventories are at historically low levels’.
Other experts agree. Robert Howell, who runs the commodities funds at Schroders, says the length of time required to increase supply will remain restricted for some time. An oil refinery takes seven years to build and bringing new copper supplies to market could take even longer. While we are all feeling the impact of higher prices – particularly at the petrol pumps – it takes a long period of rising prices before we, or companies, adjust our consumption to cope with them. And Merrill itself believes that commodity cycles can be long-lived – it thinks there have been just three in the last 100 years – and the last bull market lasted 40 years.
Investment experts increasingly see commodities as a good way of diversifying your portfolio. Their performance bears little relation to what is happening in equity, bond or property markets – witness the fact commodities were depressed for much of the 1980s and 1990s while shares were soaring. But Merrill Lynch’s fund, like its other two, will not be investing directly in physical commodities but in shares of resources companies.
While these are obviously influenced by the performance of the underlying commodities markets, they will also be affected by stock market sentiment so will not offer as much diversification as investing in physical commodities, or at least futures and other instruments in them.
For private investors, however, it is very difficult to get exposure to actual commodities. Schroders’ Howell bemoans the fact that, while the regulations on investing in virtually all other asset classes have been relaxed gradually over the years, commodities remains a virtual no-go area.
There are only a handful available – Close Fund Managers and Dawnay Day Quantum are among the few which offer them – nor, indeed, are there many investing in shares themselves. JP Morgan Fleming’s Natural Resources fund is the only other large one.
Commodities are usually associated with growth rather than income – partly because getting income from physical commodities is hard. But Merrill Lynch’s fund is taking advantage of the fact that many mining and resource companies have been generating substantial amounts of cash from rising prices, and have been using some of that to pay generous dividends. British Gas last week announced it was giving £1 billion back to shareholders while companies like BP and Rio Tinto not only have good yields, they have also been growing their dividends rapidly.
Justin Modray from BestInvest thinks the Merrill trust could be a useful part of an income portfolio although he cautions that the higher volatility of commodities, compared with shares, may make it too high risk for more cautious investors. But those with long-term horizons, and a bit of an appetite for adventure, may find it worth a look.