The recent global commodity slowdown has resulted in a challenging environment for the natural resources sector. From 2010-2015, the 25 largest natural resource companies generated an average total price return of -34%, with only two companies generating positive returns for investors. However, a closer look at the business models of natural resource companies indicates the futility of expecting significant price returns. The main reason for this is that these companies are fundamentally real estate companies, owning land and property with vast (and valuable) amounts of natural resources buried underneath. Therefore, the market value of these companies is critically dependent on the price of natural resources, which have failed to produce any meaningful returns over the last 30 years (gold and oil had compound annual growth rates of just 4% and 1.14%, respectively, from 1985-2015). As a result, these companies have largely mirrored these disappointing results.
That said, natural resource companies may still represent a lucrative investment opportunity due to their income potential, which could be very appealing to some investors.
Dividends: A Silver Lining
Typically, natural resource companies sell their assets in the market and generate cash for shareholders. Whenever assets are sold in the market, a part of company is essentially divested and, as in case of a divestiture, results in cash payouts (after servicing debt obligations).
As shown in Figure 3, companies that have returned dividends worth more than 20% of a 2010 investment over the next five years have generated overall positive (or low negative) returns for investors, despite a sharp fall in natural resource prices. It is worth noting that the worst performing investments during this period were British Gas (BG: LSE) and PetroChina (857: HK), which returned just 6% and 17%, respectively. Exxon Mobil (XOM: NYSE) is an exception to this rule, which is largely explainedby its superior price performance vs. its peers. However, even in the case of Exxon Mobil, dividends represent more than 75% of returns for investors over this time period.
In addition, valuations for natural resource companies look fairly attractive at the moment, with 6 of the top 10 companies in the world trading at a discount to their book values. Compared to 2010, nearly every company is trading at significant discount of 25%-50%. For example, the average Price to Book ratio for the top 10 companies is currently 1.09x, compared to 1.64x in 2010, and the group is trading at average discount of 32% vs. 2010. With their track record of returning cash to investors and current attractive valuations, now could be an attractive time for investors to enter the sector.
So, rather than being a simple proxy for commodities, natural resource companies may be better explained as firms that consistently distribute high levels of cash to investors every year. Companies that return higher cash as percentage of assets can not only generate higher new present value for investors, but also protect against commodity market uncertainty. Therefore, a product focused exclusively on the highest dividend-yielding companies could capture the essence of natural resource investing.
The Indxx Global Natural Resources Income Index (IGNRI) is a 50-stock free float adjusted market capitalization weighted index designed to measure the market performance of the 50 highest dividend yielding companies involved in the upstream segment of the natural resources sector. The index provides highly diversified exposure to global natural resources, including energy, materials, timber, water and agriculture, and also screens for companies that have maintained consistent, growing dividend payments and profitability over the last 12-24 months.
Since June 2006, the Index has returned 49% of an initial investment in terms of dividends, and also returned more than 3.5% of the initial investment each year (Figures 5 and 6). The impact of dividends is clearly visible when we compare the total return and price return versions of the index, in that the total return index generated an additional return of nearly 5% every year. In fact, from June 2006-December 2015, the total return index returned an annualized gain of 0.32%, vs. an annualized loss of 4.72% for the price return version of the index.
On December 21, 2015, the First Trust Indxx Global Agriculture Index ETF (FTAG: NASDAQ) was launched, which tracks the Indxx Global Natural Resources Index (IGNRI). As of December 31, 2015, the index has 48 constituents with a weighted average market capitalization of $42.24 billion and a trailing 12-month dividend yield of 7.24%.
For more information on the index and its methodology, please visit http://www.indxx.com/globalnatural.php.