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Leveraged finance

Leveraged finance

Between a rock star and a hard place

Investors stick with commodities

Gold and copper lose their lustre; Dynamic strategies replace index plays


"Oil, gold and copper just are not what they used to be," muses Blu Putnam, chief economist at the CME Group. "The hedge funds trading them got whipsawed last year." Indeed, several high-profile commodities funds closed their doors last year because of poor performance and Clive Capital and BlueGold were among several large billion-dollar commodities funds to suffer hefty losses in 2012. The January revelation that the California Public Employees’ Retirement System pension fund ( Calpers) had more than halved its commodities exposure to just $1.57 billion (0.6% of exposure) from $3.45 billion in September 2012 started speculation that an exodus from the sector is imminent.

According to Bank of America Merrill Lynch’s latest fund manager report in January, investors are now underweight commodities. Data from the CFTC in February backs this up – asserting that managers are now leaving US commodities – in particular gold. The price of gold is down around 4% this year and the CFTC data show gold to be the commodity with the largest withdrawals. Demand for gold has waned as the fear of another global crisis has diminished. As economic growth in China and India has slowed, so too has demand for gold jewellery. India’s import tax on gold has also put a squeeze on demand. Oil prices have, however, risen over the past quarter, but oil has lost its standing as a commodity in which to invest in unstable times.

Blu Putnam, chief economist at the CME Group
Blu Putnam, chief economist at the CME Group
Copper similarly has lost its shine. "It’s been bouncy for copper," says Putnam. "While you cannot build a country without copper, the growth in China and India is now slowing. Emerging market growth rates will be more like 5% to 6.5% over the next decade rather than the 7% to 8%, and higher for China that we saw last decade."

Putnam claims that institutional investors are now less inclined to buy commodity funds than before the financial crisis. "Foundations, etc, were never natural commodities buyers but they got on board between 2004 and 2007 because other people were making a lot of money from commodities. But really those investors are more naturally long equities buyers, so now that the commodities markets look a little choppy or slow, they are retreating a little."

Fund managers contacted by Euromoney tell a different story. "Capital flows look flat over 2012 into commodities hedge funds, and performance was actually worse in 2011 than in 2012," says Ken Heinz, president of hedge fund research firm Hedge Fund Research (HFR). "Last year they gained about 2.3%, which is on the low end but positive at least." Heinz has yet to witness a mass exodus from commodities-related hedge funds. He says commodity trading advisers (CTAs) were the weakest performers in the commodities market – although CTAs do not exclusively trade commodities. "Why performance has been challenged is more interesting," says Heinz. "Hedge funds have tended to trade based on fundamentals, but with the volatility of macro and political uncertainty, technical and more abstract factors have been more salient than fundamentals of supply and demand." Heinz adds that investors are continuing to pour money into macro funds in spite of weak performance. Net inflows to macro systematic funds and macro funds actually increased in 2012. "It seems that investors are not chasing performance but are rather looking to allocate money on a forward-looking basis – reducing equity hedge and allocating to macro and arbitrage strategies," he says.

Despite a weaker performance from individual commodities, such as gold, Philippe JJ Comer, managing director, commodities structuring, at Barclays, says there is still momentum among investors. "The increased appetite for alternative assets is still benefiting commodities and there is a continued demand for hard assets like gold," he says.

He adds, however, that institutional investors are changing their approach to the sector: "Where a lot of institutional clients were using simpler indices to get exposure, we have seen more interest in dynamic strategies like long commodities with downside protection. What clients recognize is that having a static exposure can be challenging and the downside volatility can be quite drastic. They are also more actively managing their commodities exposure – either from a long-only beta or an absolute alpha perspective and they are playing with prices and curves and volatility relationships. And the last thing we are seeing and expect to see more of is that investors are looking to play outright volatility."

Commodities market participants say there has also been no slowdown in retail investors’ appetite. Deutsche Bank took nearly $1 billion into its $7 billion flagship commodities ETF last year and in January added a further $200 million. "We are not seeing investors shying away," says Martin Kremenstein, head of passive investments, Americas, at Deutsche Bank. "They are more aware of the dynamics in play and are looking at products that manage the roll, but with confidence in the global economy returning this year, we should continue to see healthy inflows."

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