Investing in Commodities 2010

8/8/2019 Investing in Commodities 2010

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sset c ass i e y un s wanting to iversi yued from page 1

ned that the tighten-monetary and fiscal

will lead to increasedcurrency weakness.

ll reluctant to call iton risk, but onlye inflation statisticswhat they used to

ever, others disputeer commodities areective hedge against

on.Norrish of Barclays says: I dont see aagainst inflation toof the main benefits

osure to commodities.torically, commodi-an a reciate when

other assets dont and therehave been times in the pastwhen rising commodityprices have been a triggerfor inflation, such as in the1970s, when they were animportant factor in kick-s ta rt in g a w ag e- pr ic espiral.

But this scenario has notbeen seen for some timea nd th e r ela ti on sh ipbetween commodities andi nf la ti on has y et t o b e

tested in an era of globalisation.

If y our e l oo ki ng t ohedge inflation, it is betterto invest in inflation hedg-ing instruments like infla-tion-linked bonds and infla-t io n s wa s. That wa o u

get a product designed to doa specific job rather thanhoping another asset willprovide inflation hedgingbased on what happened along time ago.

Towers Watsons Mr Mac-Donald says the inflationhedging aspect of commodi-ties is a secondary argu-ment for holding them.Over the past two years,the price of oil has fallendramatically but inflation

has risen. Theres an awfullot of volatility out thereand, because of that, whenit comes to hedging infla-tion I dont feel commodi-ties are as efficient as otherpurpose-built financialinstruments.

Even if the efficacy ofcommodities as an inflationhedge is in doubt, few dis-pute the diversification ben-efits of holding them. Sow il l c om mo di ti es e ve rbecome a mainstream assetclass for pension funds, likeequities and fixed interest?

We e st im at e t he re s

around $290bn globallyinvested in commodities bypension funds and otherinstitutions, says Mr Norr-ish. And thats a tiny pro-portion, less than 1 percent, of the total amount ofassets held globally.

Were seeing a steadyincrease in exposure andwe believe its an assetclass that will grow, thoughits unlikely well ever seepension funds with as much

exposure to commodities asthey have to equities.

Target exposures to com-modities are usually nomore than 5 per cent, so itwi ll a lway s re ma in aniche.

Mr MacDonald believes

commodities will nmainstream asset pension funds. Tfits of commoditiement, for some fun justify the time, eexpense of the due to investigate the of such a niche asshe says.

By value, for thfunds, it makes consider commodimany are constr

rules and regulatadds.

If funds investsmall investable very huge market, decide to concentrefforts on more liquin other markets.

There have beentimes in the pastwhen risingcommodity priceshave been a triggerfor inflation


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FINANCIAL TIMES MONDAY JUNE 7 2010 1

FTfm Investing in commodities

As unpredictable as the weather

A talking point recentlyamong some investmentprofessionals has been theidea of investing in realassets, given how badlyinvestors feel let down byfinancial assets.

In this context, it mightseem tempting to look toagricultural and soft com-modities, such as wheat,cotton, sugar, cocoa andcoffee, which are so realthat we use them in oureveryday lives, unlike secu-

ritised collateralised debtobligations or credit defaultswaps.

Seductive though it mayseem, a thoughtful investorwill realise quite quicklythis is not the answer to ayearning for a solid assetthat has intrinsic value.Unless you have major stor-age facilities and probably achocolate-making business,you do not invest in actualcocoa but rather in cocoafutures.

This takes the investorstraight back to the posi-tion of investing in finan-cial assets and even thoughthe price of commodityfutures may be driven by

more intuitively obviousfactors than some otherderivatives, those

factors essentially theweather are even less pre-dictable than macroeco-

nomic developments.Investors need to thinkwhether theres actually arobust driver of long-termreturns in the market,says Simon Fox, a commod-ities analyst on the invest-ment team at Mercer.

Although there has beenmuch commentary aroundthe likelihood of a globalfood crisis, as improvingliving standards in develop-ing economies drive u pdemand for better nutrition,you also h ave to thinkabout regulatory or politicalresponses to that demand,warns Mr Fox. Few govern-ments are happy to facebread riots or h ave anycompunction about impos-

i ng p ri ce l im it s o n t hegoods their people dependon for daily survival.

I n t he s ho rt er t er m,demand is not a significantdriver of prices, because itis relatively predictable sea-son to season.

Pr ic es r es pon d t oc ha ng es i n i nv en to ry ,which are basically drivenby weather, says Tobin

Gorey, a commodities ana-lyst at JPMorgan. Demandhas an impact, but its a lotmore stable.

This is because harvestsare a product not just of theweather but also of farmersdecisions, which can be rel-atively responsive to mar-ket conditions.

If the price of onions isextremely high, farmerswill plant more onions forthe following season, thuslikely bringing the pricedown again.

Over the longer term, itmight be possible to arguethe food demand story, but

historically this kind ofproblem has been resolvednot by long-term higherprices but by improvementsin technology, allowingf ar ml and t o b e m oreproductive.

Another problem is that itis virtually impossible tolook at soft commodities asa class. They are producedin agricultural areas aroundthe globe that will experi-ence different weather con-ditions in the same season,so there is n o reason toexpect their prices to movein sync.

Indeed, checking recentlyon the 14 soft commoditieslisted on the FT.com mar-ket data page, eight hadrisen so far this year (by asmuch as 50 per cent) andsix had fallen (in one caseby 30 per cent). This is ana ss et c la ss d iv er si fi edwithin itself possibly use-ful but not one that will fitsimply into a model.

This is not to say inves-tors should steer clearentirely of soft commodi-ties, says Mr Fox.

For a passive exposureto commodities, whether asingle area or broader expo-sure, the arguments areweak, but there are someinteresting opportunitiesfor active management.

Mercer advises its clientsthey may wish to allocate

money to investment man-

agers approaching commod-i ti es f ro m a n a bs ol ut ereturn basis using theirexpertise to make moneythrou gh trading in thefutures market, rather thantaking a single long-termposition.

Fo r t he m aj or it y o f investors, active manage-ment is the sensible way to

achieve soft commoditiesexposure.

If you believe boomingemerging markets will con-tinue to fuel demand forunprecedented levels ofagricultural commodities,there are other ways to playthat conviction.

Farmland, for example, isbecoming an investable

asset class, either directlt hrough land othrough large agriculturcompanies.

Farmland is trying tcapture other sources oreturn and not just croprice changes, points ouMr Fox. Even better it alsremoves you from having tdeal with the yield curve

A barley crop is ruined in the 2006 drought in Australia Get

Soft commodities

Sophia Greneexplores the pitfallsof investing inagricultural futures

Sugar volatilityA good example of thevagaries of the softcommodities market is therecent history of sugarprices.

Global sugar prices hit athree-decade high earlierthis year, only to fall backby nearly 50 per cent (to aone-year low) when newsbroke that the Indian sugarharvest would beatexpectations.

Indias output swingsmove the country fromexporter to importer. As thelargest consumer of sugarand second largestproducer (after Brazil), thepresence of Indian demandor supply in the globalmarket is a significantdriver of the price.

India is a very opaqueplace, says Tobin Gorey, acommodities analyst atJPMorgan. This meansharvest expectations, basedon reports of what hasbeen planted and whatweather is forecast, can bebadly out of line withreality.

This year, for example,the January/February cropwas forecast to be around4.5m tonnes, some 8m

short of expectedconsumption. Instead it was8.5m, leaving a muchsmaller shortfall to be madeup.

At the start of the year,the forecast was for sugarto be at one of the tightestlevels for 50 years, so theprice went a fair way, saysMr Gorey.

With Februaryexpectations, you werelooking at two years torecover to balanceinventories. Now you canget most of the task donein the first year.

Exaggerating the wildswings in prices was thepresence of a large numberof buyers, who may havedriven the price higher thanthe fundamentals called for,and then pushed it sharplylower as they scrambled toget out of a trade they nolonger liked.

The International SugarOrganisation said lastmonth that, after a deficitof about 8.5m tonnes in2009-10, the global marketcould swing to a surplus of2.5m in 2010-11, whichwould be likely to driveprices lower.

This is an assetclass diversifiedwithin itself possibly useful butnot one that will fit

simply into a model


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fm Investing in commodities

Thirst for blueold set to grow

nvestors need morecing t han o t hershe investment poten-water. But for thoseeed little encourage-clean, fresh water is

o ne t hing : blue

r reasoning is this:freshwater suppliestic, the global popu-

is expected to jumpround 6.4bn today tobn by 2050.

er Kuffer, a seniorio manager at Sus-le As se t M a nag e -one of the first com-

to launch a waterays: Water is a pre-esource in short sup-d companies offeringtive solutions to pro-

efficient use of thisg o ld w ill pros per

han others.facts are compelling.

ding to Pictet, whichhe largest Europeanund, only a fractionwater available glo-c a n b e u s e d b y

ns. The majority iss a lt w a te r, ice o r

or is too heavily pol-

nsure that preciouss upplie s a re us e d

fficiently in the yearsand that water can

pplied t o t he co n-massive investment

to be made in waterructure, argues theouse.e US, for example, it

een estimated that$ 9 00 b n ( 61 5 bn ,

n) will be required ing between 1999 andhile in the European

expenditure total-a b ou t 3 50 b n i sd before 2025 to bring

nfra s tructure up t ovel required by EU

legislation.Inves t ors s e em t o be

warming to the argument.Since Pictet launched itswater fund in January 2000 the first of its kind thevehicle has amassed some 2 .4 b n o f a s se t s a n dincludes holdings in compa-nies such as Veolia Envi-ro nme nt, S uez Enviro n-ment, Severn Trent, andAmerican Water Works.

The success we have hadwith this fund is down tothe fact we targeted some-t hing pe ople ca n e a silyunderstand, says PhilippeRohner, one of the manag-ers of Pictets 2.4bn fund,which has produced annual-ised returns of 3 per centsince its launch in 2000 ineuro terms.

People can quite clearly

grasp that a demand andsupply issue exists, thatinfrastructure needs to bebuilt, and investment needsto be made.

Although Pictet was thefirst to market, a significantnumber of companies alsooffer water funds. As wellas Sustainable Asset Man-

a g eme nt, bo th K BC a ndSarasin run water vehiclesw hile a clust e r o f ET Fsoffer exposure to the mar-ket. These include LyxorETF World Water, iSharesS &P G loba l W a te r, a ndPo we rS ha res Pa lis a desGlobal.

In terms of the competi-tion, there seems to be amushro om e ffe ct in t hewater fund marketplace,says Mr Rohner. When theequity markets are doingwell a number of competi-tors pop up, but when mar-kets slump they tend to dis-appear.

He continues: There are

o nly a co uple o f o t he rnames out there that, like

us, have been through andsurvived the investmentcycles. The others seem to just come and go.

Mr Rohner believes com-panies often underestimatethe number of staff neededto support the investmentprocess.

T o m a k e t h e r i g h tinvestments you need tostay ahead of the regulatoryenvironment in each coun-t ry. W a t er is a hig hly-regulated sector and mak-ing investments in water-related companies withoutproper knowledge of whatthe regulator is planning isvery risky.

T he la rg e st ho lding inPictets fund is Veolia Envi-ronment, the French waterand waste water servicescompany, which accountsfor just over 5 per cent ofassets. Its largest 10 stocksmake up some 35 per centof total holdings.

M a tt Dicke rso n, chief marketing officer at Sum-mit Global Management,the US water investmentspecialist, is also a fan ofVeolia. Veolia is an excel-le nt ca s e s t udy fo r t hewater industrial business,he says.

In the first quarter of2009, Veolias water divisionrevenues were up 8.4 percent globally, 16.7 per centin the US, and 20 per centin China.

No net he le s s, t he e co -n o mi c d o wn t ur n w i llundoubtedly impact the vol-ume and rate of investmentgoing into hydro commercein the near term, Mr Dicker-son admits.

But, he says: Given thecompelling, recession-resist-ant business model, com-bined with the urgency ofwater challenges across theglobe, we believe that theoutlook for water stockstoday is much better than itwas 25 years ago, or evenfive years ago. Hydro com-me rce w ill undoubt edlyremain one of the worldsmost vital industries.

er

t regulators arening is crucialnvestors, sayss Newlands

Risks and rewardsin commodity shares

Which is better to investin commodities or com-modity-related equities,such as mining companyRio Tinto or sugar com-pany Tate & Lyle? It is an e ve r -e n di n g d e ba t eamong investors.

T he ore t icia ns t a lk o f co mmo ditie s a s re al

assets, unlike stocks andbonds, which are finan-cial assets, and say com-modities react to changingeconomic fundamentals indifferent ways to tradi-tional financial assets. Sofor example, commoditiesenjoyed an almost unbro-ken bull run from 1999 tomid-2008 while equitiesexperienced a bear marketfrom 2000 to end-2002.

When inflation is ridinghigh on rising demand forgoods, raw materials andfood then the commoditiesrise. Commodity pricesalso spike when supply ofraw materials is threat-ened, for example whenw a r o r financial crisislooms.

In contrast, stocks andbonds tend to perform bet-ter when the rate of infla-tion is stable or slowing,and commodity-relatedequties are no exception.

Broadly, when inflationis low, costs are dippingand commodity prices arefalling or stable, the equi-ties tend to outperform a s t he y did in t he 1990sand have begun to do morerecently. Macroeconomicconditions have played tothe advantage of equitiesand commodity-relatedequities since mid-2008,says Evy Hambro, man-ager of BlackRocks Gold &General fund, although he

notes that cost inflationha s be e n e dg ing up inrecent months.

Fund managers explainthat share prices of compa-nies producing or extract-ing ra w ma t e ria ls a reimpacted by a series of fac-tors, not simply the priceof the commodities. Thereis, for example, the impactof macroeconomic factors,such as interest rates, taxr at e s a n d t h e c o s t o f labour; and perceptions ofmanagement effectiveness.

All of that can weakent he link be t w e en s hareprice movements and com-modity prices. But that

ca n w o rk t o t he ca nnyinvestors advantage.

Commodity-related equi-ties can be more volatilethan the underlying com-modities, at least miningand metal commodities.

Some managers reckonon average over the longterm for every 1 per centchange in the price of gold,equities move at least 3per cent and often consid-erably more. The volatilitymakes it hard to time aninvestment just right.

But there are signifi-cant compensations for therisk of investing in equi-ties, insists Mr Hambro.Co mpa ny ma nag e me ntteams can expand, pay div-idends, discover new wells

o r de velo p ne w mine s .

They can also diversifyinto more profitable areasand create exposures tobaskets of commodities tooffset risk.

Moreover, Mr Hambropoints out there is minimala cces s t o ma ny o f t heindustrial metals such asiron ore, or the mineralsands and uranium, thathave proved so lucrative toinvestors in the past year.Inves t ors ne e d t o buys h ar e s i n c o mp a ni e sextracting these mineralsto get access.

Conversely, there arelimited numbers of pub-licly listed companies thatgive direct access to agri-cultural or soft commodi-ties, although Mr Hambroargues investors can getl e ss d i re c t e x po s ur et hroug h t he co mpa niesthat produce, say, fertilis-ers or provide the plantmachinery.

Nor is investing directlyin co mmo ditie s e venthrough exchange traded

commodities risk-free.For example, the cycle insoft commodities wheat,a g ricultura l cro ps a ndfarm produce is muchs ho rt e r a nd s e as o nal.Every year a farmer canadjust which crops he orshe plants and grows andevery year the weatherchanges.

T he fut ure s ma rke t spresent their own risks,managers add. The mostobvious is the volatilitya round t he t ime w he nfutures contracts expire.

As a mining specialist ata US bank explains, theprice of commodities isde fine d by s upply a nddemand. But a companysrevenues are based on the

price of the commodity,how effective the salesfo rce is a nd ho w muchmetal or ore a particularcompany can bring out ofthe ground.

The companies earnings,though, are dependent onthe cost of bringing thatore out of the ground thecost of plants, machinery,labour, fuel prices of oiland electricity.

Then there is the impactof management. How nim-ble have top executivesbeen in switching a com-panys focus from a low-margin to a higher-marginproduct.

A co mpa nys s kill inmanaging its cost base cre-ates huge operational gear-ing, he adds, enabling it toamplify the revenue fromhigher commodity prices.

Tate & Lyle, famous forit s ba g s o f s uga r, illus -t rat e d la s t mo nth t hee ffe ct o f ma nag e mentstrategy on returns. JavedAhmed, t he ne w chie f executive, outlined plansto steer the group awayf r om s ta r ch e s c o rnsweeteners, sugars andindustrial starches whichhad been hit by the vagar-ies of the commodity mar-ket towards higher-marginspecialty ingredients.

Mr Ahmed announced hewas mothballing a cornplant in Iowa in the face of

ethanol oversupply andvolatile margins. He wantsto supply food companiessuch as Kraft catering tothe high growth emergingma rke t s in co nsume rgoods.

Analysts say the com-panys shares are tradingat about 10 times forecaste a rnings , in line w it ho t he r co mmo dity bus i-ne ss e s de a ling in bulkingredients, but below theratings of speciality busi-nesses. The market is nowa s se s sing w he the r M rAhmed can transform theco mpa ny a nd it s s ha reprice.

Equities

There are manyfactors influencingthese stocks otherthan prices of thereal assets, writesKate Burgess

Pictet hasinvested inwatercompaniessuch asSevernTrent, whichruns theLadybowerReservoir,Peak DistrictNationalPark Alamy

People can quiteclearly grasp that ademand and supplyissue exists

Philippe RohnerPictet

There aresignificantcompensations forthe risk of investingin equities

Javed Ahmed, Tate & Lyle


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When paying fees is good

Investors are entitled to askwhy they should employthe services of an activecommodities fund managerif we are indeed in themidst of a natural resourcessupercycle in which passivecommodities funds shouldall prosper. Why shouldthey pay the extra fees lev-ied by active managersgiven that a succession ofresearch papers has shownthat active managers fail,on aggregate, to beat their

benchmarks?Armajaro, a soft commod-

ities trading house thatruns five hedge funds,argues that managers withdeep knowledge of the mar-ket are able to receive andinterpret early signals ofprice changes. AnthonyWard, chief executive ofArmajaro, notes that even ifwe are indeed in a supercy-cle, there will be extendedperiods when prices fall,and only active managerscan make absolute returnsin such conditions.

The b ig d if fe rencebetween us and passivefunds is that we can short and at times we have been

100 per cent short, he says.Mr Wards fund, CC+, tooka sizeable short position in

cocoa this time last yearand was rewarded by a 20per cent fall in the price.

He says: People assumedchocolate would be reces-sion-proof, but there was abreakdown in distributionbecause emerging marketdistributors were starved ofcash, and the price fell.

It is also easier for inves-tors in active funds to cali-brate the risks they are tak-ing, Armajaro argues; whilesome of its hedge fundslook to smooth volatility,others look for substan-tially higher returns.

Risk can be ratcheted upor down in passive fundstoo by increasing the lever-age, but index funds have

inbuilt deficiencies of whichunwary investors can runfoul. The main problem isthat the three -monthfutures contracts indexfunds buy often suffer fromnegative roll yield, meaningeach new contract costsmore than the last. It hasbeen estimated that a pas-sive fund must return 10per cent a year just to pre-serve investors capital.

In addition, says MrWard, the contracts aretransparent and anyone cantrade against you if theyknow you have thousandsof contracts to roll. Activeinvestors in a position totake physical delivery of

the commodity when thecontract expires can getround this problem. CC+,

for one, has a number oftimes taken delivery of tonsof cocoa and coffee.

While buying and holdingfutures can lead to negativeroll yield, systematic trad-ing of commodity futures,which is the strategybehind the worlds biggesthedge fund, AHL, avoidsthis through high-frequencytrading.

Systematic trading canalso help fund managementfirms avoid panicking andmaking poor investmentdecisions during times of

market dislocation. MrWard says: Systematicfunds did well in 2008because you didnt have ahuman that summer sayingthat prices were cheap. Thesystem could spot the trenddown.

Commodity-related equi-ties are another alternativeto passive funds. WillSmith, co-manager of CityNatural Resources HighYield Trust, says equityfunds have natural advan-

tages that can help them tooutstrip returns comparedwith futures-based index

funds. By finding growthcompanies, we add consid-erable leverage to the com-modity price.

Commodities equities arealso good conduits for get-ting niche, growth strate-gies into the portfolio,which index funds gener-ally dont do. City NaturalResources High Yield Trust,for example, invests in rareearths used in new ener-gies and technology anduranium, to capitalise onthe new-found fervour bygovernments around theworld for nuclear energy.

Furthermore, miningequities have the potentialto shine even if we are mov-ing into a deflationary era,

says Mr Smith, noting thattheir costs will fall fasterthan their revenues. Headds that corporate activity,possibly leading to there-rating of stocks, is a fur-ther reason to invest in nat-ural resources equities.

Others point out thatindices are weighted accord-ing to current or recentprices, but commoditieshave extremely long cyclesand prices often do notreflect reality at all. GeorgeLee, portfolio manager atEclectica Asset Manage-ment, says prices of softcommodities have been ona different planet for 30years.

Due to oversupply in theearly 1980s (think EC grainmountains and milk lakes),agriculture has been delev-eraging while every othersector has leveraged itselfto the eyeballs.

That means agriculturalstocks are historically lownow.

Even in the absence ofMalthusian outcomes,demand is growing by 2-3per cent a year while sup-ply is static, which means

prices have to rise, sayMr Lee.

The great advantage ovepassive funds that invest ithree-month rolling contracts, he argues, is thaequities are an efficient waof tapping into longer-termdemand. I can buy sharein companies such agrain storage bin manufacturers that will meefuture supply requirementnot just those of today antomorrow.

Alternative funds

Phil Davis findsactive commoditiesfund managementdoes add value

Indices show widely varying returns

Investors must be aware ofthe potential downsideeffects of investing in com-modities via indices, warnexperts.

The idea of a passiveinvestment in commoditiesis something of a misno-mer, says Simon Fox,investment consultant atMercer.

Yes, they are highlytransparent, but in factthey are trading strategies.

Equity and bond indicestrack movements in thebroad markets but definingwhat constitutes the com-modities market can be dif-ficult, says Mr Fox.

Commodity indices aremade up of futures con-

tracts from the energy,

industrial metals, preciousmetals, agriculture and live-stock sectors.

The weighting of each ofthese sectors varies fromindex to index. AlasdairMacDonald, senior invest-ment consultant at TowersWatson, says index provid-ers weight the sector alloca-tions by looking at thesupply of the commoditiesand the liquidity of thecontracts.

Generally you get someindices that have lots inenergy and some indiceswhere the allocation toenergy is deliberatelycapped to give you a morediversified blend of com-modities, he says.

The oldest and most well-known commodity index,the S&P Goldman SachsCommodity Index (S&PGSCI), has about $75bn(51bn, 61bn) of assetstracking it by far the larg-est amount for any index. Itis heavily oriented to theenergy sector, with a 70 percent allocation.

This is in contrast to

other commonly used indi-

ces, such as the Dow JonesUBS Commodity Index, theRogers International Com-modity Index, and theThomson Reuters/JefferiesCommodity ResearchBureau Index, where theallocation to energy can beas low as 33 per cent.

There is a wide differ-ence in the returns fromthese indices, says Mr Fox,because the underlyingcommodities themselves arelowly correlated to eachother and behavedifferently.

Ano ther impac t onreturns can be when theindex provider rolls thefutures contracts. Futurescontracts expire on a regu-lar basis and providers haveto purchase new contractson those commodities.

Mr Fox believes thatwhen an index is popularand transparent, other mar-ket participants will knowwhen the contracts will berolled.

Where you have a lot ofinvestors following one par-ticular index the market

knows when those con-

tracts are rolled after a cer-tain period of time. Otherparticipants will try toexploit that and erodereturns, he says.

Mr MacDonald adds:This could mean a 50 to100 basis point difference inreturns, which is quite sig-nificant. It varies quite a lotover time.

Commodity index returnsare dependent on howmuch the underlying mar-ket moves up and down called spot returns plusthe yield derived from roll-ing those contracts forward.

Another factor that dif-fers between indices isexactly where along theyield curve the futures arepurchased.

Richard Jefferson, head of

commodities sales at Deut-sche Bank, says the oldestindices buy the first futurescontract on each underlyingcommodity.

An investor gained abenefit from selling out ofthat [current] month andbuying the [next] month, asthe entry level was reset toa lower price, says Mr Jef-ferson.

This is because histori-cally most of the commod-ity curves were in back-wardation.

In the last several yearsthe commodity market hasbeen in contango, hesays, which means thefutures contracts along thecurve are trading at ahigher price than the frontfutures contract.

That contango has beeneven more acute in theenergy sector. So those indi-ces that have had a highweighting to energy andhave been invested in thefront month have seen thegreatest underperform-ance, he says.

For example, to sell out

of a crude oil contract at

todays price of $72 and buthe second contract fo$74.5, that negative roll wihave had a dramatic influence on returns.

To counteract that, number of banks includinDeutsche, developed optmum yield technologywhich optimises the poinalong the curve investorshould be able to minimisnegative roll yield.

The optimum yield technology looks at the first 1futures contracts and at thpoint of entry it will invesbased on an algorithm, ithe most efficient part othe curve. As that comes tmaturity, it rolls that baseon the same rules.

This helps to avoid mucof the negative roll yieldand outperforms traditionabenchmark index productsays Mr Jefferson.

Some advisers have alsexpressed concerns over thteam running the indexwhether it is independenor bank-led, because manbelieve banks do not havthe investors interests a

heart.

Indexing

Heather Dale looksat the developmentand use ofcommoditiesindices

Stacking cocoa at a factory in Ivory Coast. Cocoa prices felllast year because of a distribution problem Reute

Prices of softcommodities have

been on a differentplanet for 30 years

George LeeEclectica AM

The idea of apassive investmentin commodities issomething of amisnomer


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FINANCIAL TIMES MONDAY JUNE 7 2010 2

Providers compete in race for assets

Investors appetite for com-modity-related exchangetraded products has slowedthis year but competitionamong providers, particu-larly in Europe, for a shareof the market has reached afever pitch.

Already this year, provid-ers in Europe havelaunched 122 new commodi-ty-related exchange tradedproducts, compared with 66new launches last year, inwhat Christos Costandi-

nides, ETF strategist atDeutsche Bank, describes asa race for assets.

US ETP launches havebeen limited to just threethis year, due in part touncertainty over the scopeof new regulations govern-ing futures trading.

The race among Europesproviders has been trig-gered by rapid growth inthe asset pool as commodityETPs have become morewidely adopted byinvestors.

At the end of 2005, just$6.5bn was held in commod-ity ETPs, representing 7.2p er c en t o f a ll a ss et sinvested in commodity mar-

kets, according to estimatesfrom Barclays Capital.

By April of this year, thatfigure had grown to$114.6bn, making up 39 percent of a total pool of com-modity assets of $293.8bn.

But with prices for manycommodities, except gold,falling this year, net newinflows into commodityETPs have tumbled.

Barclays data suggest just$1.2bn of n ew cash h adflowed into commodityETPs by April, comparedwith a banner performancein 2009 when investors com-mitted $31.9bn.

While ETPs captured 45.3per cent of the new flowsinto commodities last year,their share has shrunk to14.4 per cent in 2010.

Data from BlackRock sug-gests inflows into US com-modity ETPs has slowed to$1.26bn so far this yearfrom $32.6bn in 2009 whileinflows into European com-modity ETPs has fallen to$ 2. 5b n c om pa re d w it h$13.7bn last year.

But although investorshave scaled back fresh allo-cations to commodity ETPs,interest from Europes pro-viders in rushing out newproducts appears strongerthan ever.

Following its decision tosell its market leadingiShares ETF business to

BlackRock last year, Bar-

clays signalled its renewedinterest in commodity-re-lated investment products

with the lau nch of n in ecommodity exchange tradednotes (ETNs) in May.

Socit Gnrale has alsolaunched a total of 43 com-modity ETNs and both ita nd B ar cl ay s p la n t oexpand their ranges.

ETNs are unsecured debtinstrumen ts issued bybanks. They are not collat-e ra li se d o r p hy si ca ll ybacked and so the holderhas a direct counterpartyrisk to the issuer. But thepricing of the ETNs doesnot incorporate a creditspread for the investor fortaking on the issuer coun-terparty risk.

I n the US, ETN s h avebeen popular with short-

term traders where counter-party risk is not a majorissue, while ban ks lik ethese products because theyare cheap and easy to build,taking just a few days tolaunch on an exchange.

Rival providers complainthat ETNs are unsecuredand so not on a par withexchange traded funds, buttheir emergence is a reflec-tion of competition for thenew money that is expectedto flow into commoditymarkets.

Deutsche Bank is fore-

casting asset growth of60-90 per cent for commod-ity ETPs in 2010, which isrobust but below the 145per cent registered in 2009.

The outlook for gold isthe k ey to future assetgrowth as gold ETPs makeup more than 60 per cent ofthe entire commodity ETPuniverse.

Heightened fears aboutsovereign debt issues andthe stability of the eurohave led to a rise in safehaven buying of bullion andholdings in gold ETPs havereached record levels at2,002 tonnes (around $77bn).

The pace of inflows hasquickened recently towardsthat seen in the first quar-ter of 2009 when fears thatthe global economy washeading for a deep depres-sion saw gold ETP holdingsswell by 465 tonnes.

Suki Cooper of BarclaysCapital says inflows in Mayare set to make it the sec-ond strongest month onrecord, and that total ETPholdings are less than 450t on ne s s hy o f t he g ol dreserves of France thefifth largest official holder.

H ow ev er , i nv es to rs

desire for easy access tohard assets has also beenreflected in an increase in

buying interest for virtuallyevery platinum and palla-dium ETP in recent days.

The platinum and palla-dium ETPs launched in theUS this year by ETF Securi-ties have attracted inflowsof around $877bn.

However, energy ETFshave suffered a setback,with US investors with-

drawing around $1.6bn thisyear while European energyETFs ha ve onl y seen

inflows of about $55m.Some analysts have pre-dicted that industrial met-als ETPs could secure a big-ger share of any increase inassets this year. These prod-ucts accounted for just 2.4per cent of all the assetsheld in commodity ETFs inApril while precious metalsmade up 74.3 per cent.

This prediction followswidespread speculation thatsome banks and producers

are considering setting upphysically backed ETFs forbase metals, particularlyaluminium.

David Thurtell, analyst atCitigroup, says althoughphysically-backed ETFsc ou ld b e a n i mp or ta ntsource of fresh investmentdemand for base metals,they face significant hur-

dles from financing anwareh ou sing costs thacould absorb too much o

their potential returns.Citigroup also says liquidity will be key for physcally-backed base metalETFs. In the event thathey want to exit the invesment, investors will likelonly be interested in holding a product if it can breadily sold to the metatrade, says Mr Thurtell.

ETCs

Competition forinvestors appearsstronger than ever,

writes Chris Flood

Heightened fearsabout debt issues

and the euro haveled to a rise in safehaven buying



7/7

22 FINANCIAL TIMES MONDAY JUNE 7 201

In vestors are tak in gflight to precious met-als, particularly gold, as

concerns grow about sover-eign debt.

Worries over eurozonedebt burden and fears of apossible resurgence of infla-tion are driving investors toan asset class traditionallyperceived as a safe haven.

People are looking forsomewhere to put theirmoney. They are looking at

gold as an alternative cur-r en cy e xp os ur e, s ay sNicholas Brooks, head ofresearch and investmentstrategy at ETF Securities,an exchange traded productprovider.

Gold funds tracked byEPFR, the US global funddata group, saw $5.7bn(3.9bn , 4.7bn) of n etinflows in the three weeksto May 19, of which nearly$5bn went into exchangetraded funds.

Investment demand drove

up the price of spot gold toa nominal record high of$1,248 a troy ounce in May,although it h as slippedslightly since then.

G ol d E TP f lo ws h it arecord of $26bn to May 25,from the beginning of 2009,buyin g more than 2,000t on ne s o f t he p re ci ou smetal, according to Bar-clays Capital.

The SPDR Gold Shares,the worlds largest goldETF, is also seeing hugeinflows into its physicallybacked product, holding arecord 1,200 tonnes with avalue of almost $47bn onMay 20.

At ETF Securities, MrBrooks has seen largerflows in the past mon thinto physically backed goldETCs than at the height ofthe financial crisis. In oneweek last month (May 7-14),trading on its ETC platformhit an all-time high of morethan $2bn, driven by strongtrading volumes in preciousm et al s. G ol d m ad e u palmost half of the trading,while platinum and palla-dium accounted for 12 percent.

This month will also see

the launch of the Physical

Gold ETC from db x- track-ers, who have until now

focused on ETFs. Most ofthe inflows into physically-backed gold stem frominstitu tion al Europeaninvestors trying to reduceexposure to the euro, saysMr Brooks. In the US, inves-tors are getting their firsttaste of physically-backedplatinum and palladiumETCs, recently launched byETFS.

A general surge in inter-n at io na l i nv es tm en tbetween January and earlyMay for both metals sawpalladium prices rise by 35per cent and platinum byalmost 19 per cent. How-e ve r, p ri ce s d ec li ne drecently as some investorstook profits after a stellar

run, particularly in palla-dium. Both metals are usedby the car industry in cata-lytic converters.

Although it may seemETPs are eclipsing moretraditional types of invest-ing such as actively man-aged commodity fun ds,fund managers say they arealso seeing increasing inter-est.

Evy Hambro, fund man-ager of the BlackRock Goldand General fund, whichinvests mostly in gold com-panies and a few platinumand diamond ones, has beengetting a spate of enquiriesfrom private family offices,hedge funds, pension funds

and retail investors.The classic question they

ask is whether to own goldthrough an ETF or invest ina [traditional] fund, hesays. Hedge funds have alsobeen building up their posi-tions in gold, including theS or os Q ua nt um F un d,which has $600m investedin gold ETFs, according tothe World Gold Council.

Wealthy investors arealso big buyers of goldETF s, especially largerinvestors, in addition tobuying bullion for theirown vaults, according toMarcus Grubb, managingdirector of investment atthe World Gold Council.

Tales abound of familyoffices trying to rent addi-tional vault space in Lon-don. At Schroders PrivateBank, Rupert Robinson,chief executive, has held anaverage of 8-10 per cent ofclients portfolios in goldand gold stocks in the past18 months.

Sovereign wealth fundsare also becoming goldbugs.L as t D ec em be r, C hi naInvestment Corp, the Chi-nese sovereign wealth fund,i nv es te d $ 1. 45 m i n t heSPDR Gold Trust, whilecentral banks have shiftedfrom selling to buying, help-ing to push up the price.

But perhaps it is pensionfunds that are making the

biggest change in direction.

Tradition ally pensionfunds shied away from gold

and commodities, says MrGrubb. In the past, pensionfund trustees said gold andother precious metals weredifficult to value and didnot have a yield, but thisis beginning to change, headds.

US pension schemes, inparticular, have been buy-ing gold, inclu ding theT ea ch er s R et ir em en tScheme of Texas and the

N ew Jersey Division ofInvestment. The former

scheme invested $125m inthe SPDR Gold Trust lastO ct ob er a nd a s im il aramount in precious metalmining stocks, setting up aseparate gold portfolio toh ol d t he i nv es tm en ts ,according to the World GoldCouncil.

However, concerns aboutgold becomin g the n ex tbubble are surfacing. AtDavos, earlier this year,

George Soros warned lowinterest rates could gener-

ate new bubbles, includinggold.Others are more optimis-

tic. Mr Robinson says thereare sign s gold may bebecoming over-owned andtoo fashionable in the short-term, but in the long-termit is a good asset to hangon to. He believes it couldeasily reach $2,000 an ouncewithin the next five years.

Gold

Ruth Sullivan tracks the recentrise in popularity of

the precious metal

Record inflows for gold funds

There are signsgold may be

becoming over-owned and toofashionable

A good asset to hang on to

FTfm

Investing in Commodities 2010

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