LSC Australian Resources Hi-Alpha Fund

Introduction

With the continuing robust demand for commodities out for China and other emerging economies, LimeStreet Capital has recognised keen investor interest in the Australian resource sector. Many executives of large companies, as well as industry observers, are noting that we have entered a period where commodity prices are increasing in real terms. Indeed, with the recent rapid recovery in commodity price, the Global Financial Crisis may appear as only a brief correction in a long term bull market.

The attraction of resource (mining and energy) companies in Australia is that they are leveraged to this increasing Asian demand. Indeed, while analysts question the sustainability of the recent Wall Street recovery in the US, a resource investment portfolio is likely to include gold exposure which will enhance returns in the expected longer term US dollar weakness.

The Resource Sector is a significant component of the ASX and has attracted overseas investors to the Australian market. It currently represents around 27% of S&P/ASX 200 share index and comprises segments including oil and gas, base metals, iron ore, metallurgical and thermal coals, steel, uranium and explorers.

However, the main Australian resource indices are dominated by the presence of BHP Billiton and Rio Tinto, which together represent about 50% of the total sector, and thus can obscure the myriad of other resource investment opportunities. These opportunities can offer attractive returns. However, these stocks are more volatile and generally require a greater degree of research and monitoring.

The LSC Australian Resources Hi-Alpha Fund will invest in Australian resources and related sectors, but exclude the resource index leaders, BHP Billiton and Rio Tinto. The Fund is therefore presented as an investment opportunity to potentially complement individual investments in BHP Billiton and/or Rio Tinto.

Investment process

LimeStreet Capital will manage the Fund as an active and high conviction portfolio. It will assess the following aspects in determining appropriate investments:

Global economics and relative global valuations;
Individual commodity price cycles;
Asset quality;
Management quality;
Fundamental value;
Relative value; and
Momentum trends.

Based on its experience, the LimeStreet Capital management team believes that the market may value resource stocks using different drivers at particular times. For example, during bull markets in resources a key share price driver is commodity price momentum, while during bear markets investors more closely scrutinise earnings and cash flow generation, as well as estimates of net present value. At other times, relative measures based on enterprise value per production, reserve or resource quantity are pertinent to market pricing. In addition there are specific company attributes, such as exploration success rate and management’s ability to implement large projects on time and on budget, which lead to a stock trading at a premium or discount to its peers.

Essentially, LimeStreet Capital recognises that significant flexibility is required in selecting appropriate investments and managing the portfolio to capture the returns offered in this sector, and part of the investment process includes estimating what drivers are currently operating.

Investment objective

The Fund will invest in listed Australian resources and related sectors, but exclude the resource index leaders, BHP Billiton and Rio Tinto.

The Benchmark Index for the Fund is the S&P/ASX Small Resources Accumulation Index (Small Cap Resources Index) which, despite its name, includes companies with capitalisation of greater than A$3.0 billion. The objective of the Fund is to outperform this index by at least 3% per annum.

LimeStreet Capital’s approach is to offer a fund specialising in investments in this portion of the resources sector which is not burdened by the large index weighting of BHP Billiton or Rio Tinto. Investors could potentially use an investment in the Fund to complement direct investment in either or both of these two larger companies.

Investments held and features of the fund

The Fund will invest in a broad portfolio of Australian listed companies with a focus on resources and related sectors. These sectors ultimately respond to world growth and the unprecedented commodity demand emanating out of China and other emerging economies.

The Fund can invest to a maximum of 15% of the Fund in any specific company and is not necessarily restricted to companies within the Index, although companies within this Index are likely to dominate the Fund portfolio. The Fund can also invest in related sectors, for example agricultural and mining services which are aligned with resources and commodity markets, and to similar macro-economic factors.

Further features of the Fund are:

the Fund will not be geared;
the Fund will not use derivatives or hedging strategies;
the Fund can hold up to 100% cash at any time; and
a performance fee of 20% is payable to the Investment Manager on returns above the benchmark plus 3% p.a. (i.e. the fund must outperform the benchmark by at least 4.5% before the performance is payable on further performance)

In relation to the performance fee, performance fees are accrued daily and paid annually. Performance fees attributable to outperformance which is less negative than the index are accrued but not paid. Any previous past underperformance relative to the benchmark must be recouped before performance fees may become applicable.

LimeStreet management believe this is a fair structure which ensures that investors are adequately rewarded before performance fees may become applicable while not being disadvantaged with the payment of performance fees during falling markets.

Fund establishment and service providers

The Fund was established by a Constitution dated 13 February 2008 and registered with ASIC on 28 February 2008 as the LSC Australian Resources Hi-Alpha Fund.

LimeStreet Capital is the fund manager and the LSC Australian Resources Hi Alpha Fund incorporates the services of the following well established companies in their specific areas of expertise:

Responsible Entity: Equity Trustees Limited
Administration: Mackenzie Coultas Funds Administration Limited
Custodial: ANZ Custodial Services

Classes of units

At present the Fund has one class of units. However, as the Responsible Entity, EQT has the discretion to issue further classes of units from time to time without notice to unit holders. As the Responsible Entity, EQT is obliged to treat unit holders of the same class equally and unit holders of different classes fairly.