Adventurous Investor: Two small-cap mining funds

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Knowing exactly what you are getting into is particularly important when it comes to commodities. Buy a single exchange-traded commodity (ETC) on copper, for example, and you’re not buying copper spot prices but forward futures prices – which can frequently go the wrong way, from an investor’s point of view. Buy a commodity fund to chase the trend in underlying commodity prices and you may track equity prices instead – BlackRock World Mining Trust has an excellent track record under Graham Birch and now Evy Hambro, but is more closely correlated to equities than it is to commodity indices.

For those interested in accessing London and Toronto’s growing pool of small-cap miners, there are a few funds – such as the Junior Mining Trust and Altus Resource Capital – poking around in this volatile sector, but they have their limitations in my view (see box below). In fact, I reckon there is just one decent bet: the £160m market cap City Natural Resources High Yield Trust (ticker CYN), managed by Richard Lockwood and Will Smith. I’ve long held shares in this London-listed fund because of its aggressive active management style. When it comes to explorers and small miners, I think you need managers with access to detailed research and technical knowledge to sort the nuggets from the spoil.

But there’s another niche in the small-cap sector that may be worth investigating: private miners looking to float in the next few years. Theoretically, if investors can find well-run companies and buy in at decent prices, they can ride the “mid-stage” growth cycle and then profit from the initial public offering (IPO) of shares – which astute fund managers, such as those at City Natural Resources, will buy. This can work well when markets are in a bullish phase.

Up until now, however, there’s been no way for private investors to play this small-cap mining strategy. But, next week, that should all change with the listing of Baker Steel’s Resource Trust, which is looking to raise £50m-£150m via a placing of ordinary and subscription shares.

I like the look of this fund for a number of reasons.

First, it plays the pre-IPO game and already has a decent portfolio of late-stage miners that are busy mining their way to profit. This portfolio was inherited via the restructuring of the manager’s Genus Capital Fund – more on that later.

Second, the managers have technical expertise in this field, having come from the extremely successful BlackRock stable. Their advisers include Rock Capital and AWR, and they have a team of geological specialists to call upon.

Third, the managers are not taking any risky, macro plays on particular commodities. They have a small bias towards industrial metals, but there’s no obsession with precious metals, which I applaud. Instead, the managers are focused on a value-driven analysis of any particular mining business and its ability to generate future cash flows.

Fourth, I’m impressed by the existing shareholders, which include RIT Capital Partners (my preferred default investment trust) and RBC Capital Partners.

Add in the fund’s London listing, and lack of any leverage, and I think you have a great way of playing a specialist – but potentially lucrative – niche market.

I’d also recommend taking the time to look in detail at the holdings inherited from the Genus portfolio: it is a tight portfolio of fewer than
20 investments, with a focus on Mongolia (Gobi Coal), Brazil (Ferrous Resources) and the Democratic Republic of Congo (Ivanplats).

If the bull market continues to power ahead – and that’s a big “if” – then I reckon the subscription shares could be an attractive geared play on the portfolio of assets. All it would take is a successful IPO of one of the major holdings for investors to make some decent profits.

But there are downsides in addition to the inherent risk of backing miners, and the biggest of these is cost: the fund has an annual management charge of 1.75 per cent and a performance fee of 15 per cent of all gains over 8 per cent. Expertise in this sector clearly doesn’t come cheap!

Illiquid gold

Investors seeking diversified exposure to small-cap mining stocks have few choices.

The Junior Mining Trust does invest in this sector and is run by Jim Slater’s son-in-law, Angelos Damaskos, who also runs the Junior Oils fund. But I think it’s fair to say that Mr Damaskos is not exactly renowned in the City as a mining expert – although his oil fund has been a success.

Altus Resource Capital is another London-listed specialist fund that focuses on small caps. But, in my experience, its shares are not very liquid as there are just two market makers, which also means the shares trade on wide bid-offer spreads.

What’s more, both funds have a gold bias – a fatal flaw in my view, as I reckon the gold price will soon fall. If, however, you think I’m wrong about gold, there is an index tracker alternative from ETF Securities: the DAXglobal Gold Mining Fund (ticker AUCP).

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