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Commodities: Get smart or get washed up

The first wave of easy returns on commodities has passed, while allocations continue to grow. Traditional players are having adapt to a much more liquid market, swimming with a new breed of investors and their active hedging strategies. Peter Koh examines the changes.

ASSETS UNDER MANAGEMENT invested in passive commodity indices have shot up by $75 billion over the past six years to reach an estimated $80 billion. More money is heading in the same direction, but the first wave of easy returns has played itself out. Now investors will have to get smarter to equal or exceed them.

More sophisticated investors are starting to look beyond passive index investing and towards more active styles and more exotic trades. There is no shortage of derivatives on offer from leading investment banks, and the level of complexity possible in commodity instruments is now approaching that seen in other markets. But the direct import of derivative structures familiar in other asset classes is not without its critics.

The market’s traditional players – those that actually produce and consume commodities – are having to adapt to a market increasingly driven by financial investors that have no interest in the underlying goods.

Investor interest in commodities shows no sign of abating. A survey conducted by Barclays Capital at a commodities conference it held in Barcelona in February showed that although half of the respondents did not already invest in commodities, only 7% expected to have no allocation by 2008.

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