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“We are seeing more and more multi-strategy fund managers adding commodities to their portfolios” Ben Jackson, Kiodex |
According to SunGard Kiodex, a web-based commodities risk management platform for financial institutions, commodity hedge funds are rising in number. The most recent evidence comes from Citigroup, which is reportedly seeking to raise up to $2 billion for two new hedge funds that will be managed by the US bank’s energy trading subsidiary, Philbro. Leslie Barbagallo is a senior vice-president at Kiodex, where her responsibilities include assisting hedge funds and their investors with risk management due diligence. She says that, according to Kiodex’s listings, over the 20 months from September 2005 to May 2007, the number of hedge funds trading commodities (including multi-strategy) grew by 63% (39% annualized). There are now an estimated 300 hedge funds that specialize in trading commodities, and a growing number of multi-strategy funds that are adding expertise in commodities trading.
Ben Jackson, COO and head of Kiodex, says: “We are seeing more and more multi-strategy fund managers adding commodities to their portfolios. The reasons vary from creating relative-value plays to adding assets that aren’t necessarily correlated to the returns and volatility of the other asset classes in their portfolios. Hedge funds are also expanding their breadth of commodity strategies as markets grow.” He adds: “Many commodity hedge funds were focused on US natural gas about two years ago. Now we are seeing more and more strategies looking at sectors such as power, freight, and agricultural products.”
The growing global interest in green issues is also encouraging funds to trade in ethanol and emissions. “For example, the convergence towards ethanol is creating volatility in corn markets and that is spurring fund strategies in those areas,” say Jackson. One strategy being employed is that of bets on the spreads between biodiesel fuels such as ethanol and biodiesel inputs such as corn.
Houston-based ETG Capital launched an energy fund in June and plans to raise as much as $500 million in the next three years. Co-founder Don Addison says: “We first started looking at the space about four years ago but it was still too close to the merchant energy debacle. When Enron went into bankruptcy, the repercussions were felt throughout the industry and the resulting credit issues gave rise to counterparty clearing. Prior to Enron, to trade commodities on the power side, for example, you needed a large balance sheet. The rise of clearing through exchanges like Nymex and ICE, which allows you to transact with a much broader spectrum of players, considerably lowered the barrier to entry and allowed for the emergence of hedge funds focused on energy trading.”
The growth in the number of commodity funds is increasing the demand for skilled individuals. Addison says: “Because of the resulting downturn in the industry after the collapse of Enron, there was a significant reduction in trading positions and junior traders with less experience left the market. As the industry rebounded and opportunities emerged, the call on talent became much stronger and for the last couple of years it has certainly been a traders’ market. Traders who have been around since before the collapse of Enron, and who have a demonstrated track record, have been very much sought after by the banks and funds. Even what the industry considers mid-tier talent that has been in the industry for five or six years and has a decent resume is in high demand.”
Jackson says that he is seeing a lot of talent being poached out of energy companies into the banks and hedge funds.
Despite the growth of commodity hedge funds, investor demand has been muted. However, it is steadily increasing. Stephen Williams runs a commodity fund of hedge funds at Harcourt, a fund of hedge funds based in Zurich. His fund was set up in February 2005. “Investors have been a little nervous since Amaranth, which, although it was a multi-strategy fund and not a pure commodities fund, nevertheless lost its money in natural gas,” he says. “While the market dealt with that very well, and the losses were contained, it hasn’t so much put people off though, but made them much more focused on risk management.”
The fund of hedge funds market still appears to be the favoured way of investing in commodities for institutional investors and high-net-worth individuals. As it is an extremely broad and complex market, investors are understandably nervous about the level of risk management that start-ups are employing.
Williams says his fund of funds looks for managers with a two-year track record and a reputation for high returns. He also prefers managers that do not raise a very large amount of assets in a short space of time.
