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   APRIL 2020
Hard hit, but
poised for a comeback
  PAGE 21
    Slow global economic growth has taken a toll on natural resources, but monetary and fiscal stimuli could prove a boon to the sector when markets recover
chemicals that can be used in products as diverse as agrichem- icals, semiconductors, colours, cosmetic additives, food addi- tives, paints and textiles. He also likes specialty gases used in industries such as phar- maceuticals, electronics and petrochemicals.
As of Feb. 27, the RBC fund had a geographically diversified portfolio, with 47% exposure to the U.S., 16% to Canada, 13% to the U.K., 9% to France and the remainder elsewhere. The port- folio’s asset mix as of Feb. 28 was 48.1% in oil, gas and con- sumable fuels, with an overall underweighted exposure to oil; 20.8% in chemicals, including specialty gases; 19.1% in metals and mining; 4.1% in containers and packaging; and the remain-
der in construction materials. Among the RBC fund’s largest holdings are Ireland-based Linde PLC, the world’s largest indus- trial gas company, as well as two multinational integrated energy companies: Total SA of France
and Chevron Corp. of the U.S. Over the past six months, Spilfogel has been selling energy stocks and increasing the RBC fund’s exposure to industrial gases and specialty chemicals companies. He also has increased the portfolio’s allocation to gold, “which has been doing very well
over the past year.”
Overall, Spilfogel looks for
businesses that “are less cyclical [and] have secular growth, higher rates of return on invested capital and decent free cash flow. There are a lot of companies in the materials sector that meet these criteria, compared with energy companies, which are under pressure because of climate change.” However, he believes “some energy companies will do well in the long term.”
benoît gervais is senior
vice president, portfolio man- ager and head of the resources portfolio team with Mackenzie Investments in Toronto, and lead portfolio manager of the
$62-million IG Mackenzie Global Natural Resources Fund (along with Onno Rutten, vice president, investment management, who also works with the team). Gervais believes that resources stocks “are massively underpriced” and will recover once the global economy, and emerging markets in particu- lar, recover.
When investing in natural resources, Gervais focuses on the ability of companies to gen- erate and sustain free cash flow. Some companies may have cur- rent cash flow that is reinvested in replenishing reserves and replacing obsolete products and equipment, leaving them with no unencumbered or free cash flow.
With this in mind, Gervais’ resources team uses a sustain- able free cash flow model in combination with a disciplined quantitative risk-management overlay to select companies. This process ranks companies based on their estimated free cash flows over a period using high and low projections of commodity prices.
“It used to be OK to get zero dividends and 12% growth,”
Gervais says of his return expect- ations, “but today I can tell you nobody wants that — nor do I. I want a combo of 4% or 5% growth and the rest in dividends.”
Gervais also focuses on environmentally sustainable investing. “The world is just starting to find solutions around climate change,” he says. “We are caught right in the middle of the line of fire between environ- mentalists and capital markets trying to reconcile [what] a bet- ter future looks like and how it may or may not involve natural resource products.”
For example, oil and gas companies are not favoured by environmentalists, Gervais says, adding that natural gas is “not the purest answer” to climate change, but natural gas does “reduce emis- sions versus coal by more than a half.” The purest answer would be all renewable energy, he adds, but you need batteries to make renewables work “when the sun isn’t shining and the wind is not blowing.”
Gervais also favours greater use of renewable lumber resour- ces and natural fibre-based con- tainerboard in place of cement in the construction industry. He also favours the replacement of plastics in packaging, a shift to
zero-emission electric vehicles and the acceleration of wind and solar power growth.
As of the first week of March, the IG Mackenzie fund holds a geographically diversified port- folio. About 77% of its assets is held in North America, 14% in Europe, and 6% in Africa and the Middle East.
The asset mix is about equally weighted in energy and related stocks — including oil and gas and consumable fuel compan- ies, refiners and pipelines — and materials and related stocks. The IG Mackenzie fund holds about 20% in metals and mining, including base, ferrous and pre- cious metals; approximately 10% in chemicals; 7% in paper and forest products; 3% in containers and packaging; and the remain- der in industries such as energy and equipment services, gas util- ities, and industrial power and renewable electricity producers.
Among the IG Mackenzie fund’s largest holdings is Calgary- based Tourmaline Oil Co., a sen- ior crude oil and natural gas exploration and production company, which, Gervais says, “is localized, will grow and will pay a dividend.” Tourmaline, he adds, will benefit from replacing coal with natural gas. The com- pany also operates in Canada — one of the cheapest places in the world to produce natural gas.
Another large holding in the IG Mackenzie fund is AngloGold Ashanti Ltd., a South Africa-based global gold producer with oper- ations in more than 20 coun- tries on four continents. Gervais says that in addition to gold per- forming well, he believes there will be a “move away from paper assets,” which benefits the metal.
The IG Mackenzie fund also holds Toronto-based Norbord Inc., a large, climate-friendly manufacturer of wood-based panels and particleboard, which will benefit from the shift away from use of cement. “The com- pany is well-managed, has some of the lowest costs and pays a dividend,” Gervais says.
Over the past year, Gervais sold holdings in several U.S.- based shale-oil producers, including QEP Resources Inc. and Callon Petroleum Co., both of which don’t have free cash flow, which makes their operations unsustainable. He “brought the money back to Canada.”
While the coronavirus has sent the natural resources sector into a tailspin, Gervais anticipates that the sector will recover once global economic growth resumes and provides scope for stocks to return to their historical multiple ranges. The fundamental trends in place for natural resources prior to the Covid-19 outbreak still are unlikely to change meaningfully in the future. IE
investors seeking expos-
ure to energy and materials can invest in natural resources mutual funds. While the sector typically is volatile, the Covid-19 pandemic has triggered height- ened volatility in all sectors, thus weighing heavily on commodity prices. The crisis has resulted in mass production shutdowns and supply-chain disruptions — par- ticularly due to port closures in China, one of the largest buyers and suppliers of commodities.
The energy component of the natural resources sector com- prises companies producing non-renewable energy such as oil, natural gas and nuclear power, as well as those that produce renew- able sources of energy such as hydro, wind, solar power and biofuels. The materials compon- ent includes industries involved in chemicals, construction materi- als, containers and packaging, metals and mining, and paper and forest products.
The performance of natural resources mutual funds, which often are regarded as specialty funds, typically are influenced by many variables. The demand and supply drivers for natural resour- ces are linked directly to global economic growth. The healthier the global economy, the greater the demand for raw materials pro- duced by companies in the sector.
For example, Covid-19 has accentuated slower economic growth in China, the world’s lar- gest consumer of raw materi- als, and that has had a negative impact on supply and demand. On the other hand, the shift toward greater use of electric vehicles has spurred increased demand for metals used in bat- teries for electric cars.
Other variables that may affect the performance of the natural resources sector include monetary and fiscal stimuli, which are designed to spur eco- nomic growth and consequently support demand; geopolitical and trade tensions, which could negatively affect demand; and the shift to environment, social and governance-based investing, which could either initiate
greater efficiency and innovation in the natural resources sector or constrain the growth of specific industries.
Brahm Spilfogel, vice presi- dent and senior portfolio man- ager, global equities, with RBC Global Asset Management in Toronto and lead portfolio man- ager of the $108-million RBC Global Resources Fund (together with Chris Beer, vice president and senior portfolio manager, global equities), uses “a couple of different styles” to select nat- ural resources companies.
For companies in the energy and diversified metals space, Spilfogel looks for “one of two things”: companies with the ability “to grow cash flows in a flash” or companies that “have very good free cash flows for a longer period” based on their resources, which enable the companies to pay a dividend.
To choose companies in the materials space, Spilfogel uses a “fairly thematic approach” to find companies benefiting from specific future trends. He likes Ireland-based Smurfit Kappa Group PLC, one of the world’s leading paper packaging compan- ies, which also produces environ- ment-friendly paper-based products that can replace plastic.
Spilfogel contends that people will pay for environ- ment-friendly products, provid- ing these companies with sound growth trajectories, good free cash flow over the long run and a healthy return on invested cap- ital — which together are at the core of Spilfogel’s investment decision-making process.
Spilfogel says there also are thematic opportunities in the diversified metals and mining space. For example, the tran- sition to electric vehicles will benefit companies producing diversified metals such as cop- per, nickel and lithium for use in batteries. “For the next 30 years, the demand for those metals will be quite large to satisfy the mar- ket,” he says. “Diversified metals mining companies will benefit from that long-term trend.”
Spilfogel likes specialty
   When investing in natural resources, Gervais focuses on the ability of companies to generate and sustain free cash flow

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