Investment Universe, Process, Strategy and Benchmark – How does the Fund Manager invest? (ISIN: DE000A0J3UF6)The Earth Exploration Fund is a “long-only” fund. The management strategy focuses on the active management of the portfolio, i.e. the aim is to provide a portfolio return that exceeds a fixed return (7%). The decision process consists of two parts: macro and micro portfolio construction. 1.1 Macro component
Top-down inputs for commodity prices, currencies and inflation rates will be derived from a centralized database. The commodity prices are adjusted regularly (on a quarterly basis). A wide network of highly ranked brokers and commodity analysts provides guidance in the top-down approach.
The macro component of the portfolio compares market capitalizations, outlook and liquidities for the various commodity sub-sectors (precious metals, base metals, etc.), aiding the definition of weightings of these sectors in the portfolio. Further consideration in the weighting process is given to geographical distribution, liquidities, and market capitalization of the sectors.
1.2 Micro component and Ranking
The stock selection process within the portfolio construction process focuses on a bottom-up analysis (see below) and the subsequent ranking of stocks. The ranking process is crucial in this regard and is integrated within the ERIG FUNDS database, taking into account the following valuation parameters:
• Expected return
• (2-year) NAV growth
• Project Financing
• EBITDA margin
• Market cap
2 The ERIG value approach
The Earth Exploration Fund UI invests “away from the benchmark”. Investments will only be guided by the company valuations. Focus will be on “undiscovered” companies and projects. We believe that the technical skills set of the investment team (mining engineers, geologists, geophysicists in addition to sophisticated financial analysis) allows for deep value recognition in the commodities sector. The value approach should offer potential for capital gain, regardless of the long term increase of underlying commodity prices. However, due to the focus on the small- and midcap sectors, this value approach is unlikely to result in superior returns during phases of risk aversion and “panic selling”, i.e. when market participants ignore the fundamental value of companies.
3 Portfolio construction
The portfolio consists of 35-45 stocks. Although stocks with market caps below US$300m will be considered, liquidity constraints will limit the number and weighting of such stocks. Such companies do not present more than 10-20% of the portfolio. The portfolio is actively managed, i.e. a stock will be sold, if a company’s share price exceeds its determined target price. Target prices will also include a take-over premium (in general 30-40%).
The fund actively switches between commodity subsectors, and can e.g. increase weightings in oil/energy, when our view suggests that this sector has a better outlook than the precious metal or base metal sector.
Performance Review 2007
Joachim Berlenbach: "The Earth Exploration Fund UI could outperform its peer group during the first year since inception (October 2006 – July 2007). This outperformance was achieved due to the focus on well researched and significant undervalued small and mid cap stocks.
However, during phases of significant market corrections (e.g. July 2007, November 2007), the less liquid stocks invested in showed a higher downward correction than the benchmark. As a general characteristic it can be observed, that the fund performance can drop faster than the benchmark’s which focuses on larger cap stocks.
The portfolio management team addresses this by investing in higher cash quotas and especially the investment in put options on indices, which have a high correlation with the fund. These “protection tools” will in future allow for a reduction in volatility during phases of severe market corrections."
Performance Review 2008
Joachim Berlenbach: "During the 2008 financial crisis equities fell sharply. However, small and mid cap stocks fell even faster, due to higher perceived risk and lack of liquidity. The general flight out of equities and in saver asset classes resulted in a severe drop in the fund performance. As a result the fund underperformed its peer group.
Stocks were severely undervalued at the end of the panic selling phase (November 2008), with the first “contrarian” investors taking advantage of the attractive fund valuation and re-investing into the fund."
Performance Review 2009
Joachim Berlenbach: "After the severe selloff in 2008, which was partly driven by panic selling and not by fundamental valuations, the invested stocks showed historically low valuations. For example, some market caps were below net cash holdings, which emphasised the attractive valuations of the fund. With a return of the market to value investing, the fund could significantly outperform the shown benchmark (+153% vs. 31%).
The performance was aided by subsector allocation, with emphasis on gold and base metal (especially copper) producers and explorers, which showed a quicker recovery than for example oil stocks.
The positive performance during 2009 emphasised the observation that the Earth Exploration Fund UI can outperform its peers in times when the market is driven by fundamental valuations."
Performance Review 2010
Joachim Berlenbach: "Especially in the second half of 2010 the fund could show a strong performance (64.9% return). The markets were in “fundamental valuation” and significantly undervalued small- and midcaps could outperform the “mainstream sectors”. Especially base metal (copper) and gold stocks were supported by strong underlying commodity prices. During 2010 (ytd) the fund continued its positive performance. In addition to subsector allocation (e.g. overweight in precious metals and base metal stocks until Q3 and then switching into oil stocks from the end of Q3), the attractively valued small and mid caps invested in resulted in a wave of take-over activity, of which the fund could significantly benefit in the second half of the year.
During the observation period many companies in the portfolio were taken out during M&A activities, which also supported the fund performance. Subsector allocation remains an important portfolio management tool."
Performance Review 2011
Joachim Berlenbach: "Equity performance in 2011 was to a large degree determined by risk aversion amid the European and Greek debt crises and a flight into “safe haven” assets and out of commodities and equities. Small and midcap stocks were especially vulnerable to the sell-off and consequently resulting also in this fund suffering a negative performance (-40%). Moving into midcap stocks and out of oil equities in the second half only provided little relief. Towards the end of the year some increased risk taking resulted in a consolidation of the performance, but volatility remained high."
Performance Review 2012 - Year-to-Date
Joachim Berlenbach: "The risk aversion seen throughout 2011 remained an important investment focus during the first quarter of 2012. The Euro and Greek crisis, growth concerns in China and the US economic developments all impacted on market sentiment. Amid constantly high commodity prices and some return of investor confidence the underlying equities recovered somewhat from their downturn in 2011. The fund could return 11.47%. Nevertheless, volatility remains high and we do not see a convincing change of investor sentiment in the near term. Risk aversion is expected to remain an important part of many investment strategies."
Performance since 2007
Joachim Berlenbach: "The fund performance graph since inception shows the drawback of investing in mid and small cap stocks: these perform worse during times of strong market corrections when risk aversion prevails (2008, 2011). However, the solid bottom-up stock selection approach can result in superior returns when the market is focused on fundamental analysis (2009, 2010, first quarter 2012). Since the fund cannot “go short”, risk management includes investing in larger cap companies and holding a higher cash quota (up to 30%)."