The Sceptre UK Fund was up by 3.1% in May, a strong performance which compared with a rise of 2.5% for the FT All Share Index in the month. The fund is now up by 23.6% over the last 12 months after all fees (compared to the index being up by 17.9%) and by an average compound annual return of 17.7% after fees (and by 21.7% before fees) since inception 2 years ago.

The fund is about 85% invested and we have found 4 new holdings for the fund so far in 2007 to replace holdings which reached their fair value toward the end of 2006, although we continue to search, we are finding more companies that are too expensive or “fair value” than we would like. It is at times like these that we know our patience and a small cash weighting will enable us to take advantage when a potential purchase opportunity arises.

At Sceptre we spend most of our time valuing companies and have historically avoided those companies whose earnings are based on assets that we cannot accurately forecast future prices for, such as commodity prices underlying mining companies’ earnings. However this is not to say that we avoid examination of the fundamentals for these companies, and we currently estimate that the returns on capital being generated by the larger listed mining companies in the UK are 2-3x the level of 5 years ago and remain significantly above what we expect to be the cost of capital for the industry.

Driving these excessive returns has been the rapid increase in selling prices experienced; for example copper has increased in price by more than 5-fold in the last 5 years, whilst worldwide production has only increased by 10% and capacity utilisation has declined by 5%. On our calculations, one large UK listed commodity company needs to sell all its known mineral reserves at today’s market prices to extract “fair value” from the current share price. This valuation therefore takes no account of the potential for production growth, demand falls or for the potential for substitution of other materials for copper – with a potential resulting fall in demand. Companies who mine commodities are replacing their assets by buying smaller exploration companies but they are now locking in their reserve costs at current prices.

As we previously stated – we try to avoid forecasting future prices of commodities, but the share prices of some larger mining concerns listed in the UK, now making up a significant weight within the index, currently discount prices of commodities remaining at levels broadly similar to those now in the market, despite the effects of lower demand at higher prices and attraction of new capital to excess returns – simple business concepts which we still believe apply in this case. So despite many companies which have experienced rapid increases in profits and share prices as a result of this boom now being suggested as ‘value’ plays with low P/E’s we remain watching on the sidelines.

As always, if you have any questions on our approach or performance, please let us know.

Chris Broadhurst
CEO