We had taken a positive view on commodities early on, and added the theme through our ‘Economic Revival’ category under Thematic Investing since our inception in January 2020. But we added a commodity fund as part of the Strategic/thematic section in Prime Funds later in March 2021. The call was a bit late but yielded good results. Now we would like to alert you to book profits on this equity fund (NOT sell) and prune it back to your original capital.
The fund is ICICI Pru Commodities Fund. And it will continue to remain in Prime Funds, under the Strategy/thematic category, for now.
The fund and performance
ICICI Pru Commodities Fund delivered an absolute 33% return since our call in our March 2021 quarter review. This return is more than double that of the broad market Nifty 500’s return. Yes, we could have locked into higher returns had we given the book profit call a bit earlier but the Russia – Ukraine tension made us believe that the rally could last longer.
However, we now see that the market has a divided view on commodities. We would therefore prefer to play it safe by recommending that you pocket some of the gains.
When we gave the call on this fund, ICICI Pru Commodities played the ferrous metal rally in full force that led to a 71% gain in the fund in 2021 alone. As can be seen from the data below, stocks of steel and iron products started their rally in late 2020 but soared in 2021, backed by supply side constraints and the scarcity created by Covid followed by the demand surge post Covid. This resulted in commodity prices peaking. Lower output by China to control emissions also played a large role. Alongside, non-ferrous metals also gained, albeit lower than ferrous metals.
While metals showed signs of cooling off by end 2021, the Russia- Ukraine war once again lent strength to the commodity price story. That has cooled off a bit now. The World Bank’s commodity outlook April 2022 also suggests more softening of metal prices, both ferrous and non-ferrous.
More importantly, in a move to combat inflation, the Indian government recently imposed hefty export duties on steel and its raw materials. This was to preserve domestic supplies as steel companies were enjoying both realisation and volume from exports in recent years post the decline in Chinese production. This steep duty will not be adequately compensated by the cut on the raw materials import duty (coking coal, metallurgical coke, anthracite coal and other inputs) as these had low duties of 2.5-5% in the first place.
This means that lower exports will have to be compensated for by local demand. Even if demand remains robust locally, margins may take some hit as some of the products by steel players are exclusively done as value-adds for export markets (5-25% of their production).
While ICICI Pru Commodities still has 20% of its portfolio in ferrous metals, the robust returns seen in 2020 and 2021 may not come from this segment. The fund has consciously tried to preserve the gains by steadily reducing exposure to this industry. From 36% exposure to ferrous metals in March 2021 when we gave the call, it reduced it to 25% by December 2021 and 20% by April 2022.
We think the fund’s neutral stance now - reducing ferrous metals but not going too underweight - might help make some returns if inflation cools off and export duties are removed or if local demand, triggered by both capex and real estate activity, picks up pace. And a cooling off of input costs would also help these companies deal better with margins.
However, a quarter or two of weak earnings (already seen in March 2022 quarter) is likely to keep metal stocks either muted – or more severely hit stock prices if a steeper market correction happens. Hence, some profit booking at this stage will be prudent for existing investors to lock into gains already made.
Where the fund sees potential
But apart from metal companies potentially managing margins and realisations, other moves the fund has taken help retain the performance potential.
ICICI Pru Commodities has upped its exposure to the beaten down cement sector as a more contrarian approach. It increased its exposure from as low as 5% in March 2021, to 21% in December 2021 and 38% as of April 2022. Essentially, it upped exposure to this space as it pared exposure to the ferrous metals segment.
We see this as a contrarian bet that can bear fruit over the medium term. After steady returns of 46-47% on an average over 2020 and 2021, cement stocks took a hit in 2022 (stocks down 18% on an average from January-May 2022) as surging fuel cost hit margins even as realisations remained muted as demand was a bit weak.
Going forward, while demand may continue to be sedate till the monsoon season ends, this may be a period of consolidation in the industry as the Adani Holcim deal clearly proves. Read more about the Adani-Holcim deal and how it can impact the cement industry in our article. The cement industry has already seen a bit of consolidation and this adds impetus given that Adani’s plans can clearly shake the industry out of its capacity slumber.
We think ICICI Pru Commodities is trying to play this consolidation, with the fund having exposure to Ultratech as well as Ambuja-ACC combine. But we expect this to play out slowly and investors should be willing to wait it out when it comes to performance of this fund, at this juncture.
What you should do
- If you held this fund for a year or so, book profits. Keep your original capital intact if you don’t need this money for the next 2 years.
- You can consider reinvesting the profit booked in diversified equity funds if you prefer lower risk or wait for our call on another upcoming sector opportunity next week.
We continue to keep this fund as part of Prime funds given the tactical shift that the fund has made into a more contrarian sector. We will be watching for the theme to play out or come out with a call if it warrants an exit later.