Commodity investor inflows rebound as sector outperforms shares

Thu Apr 17, 2014 9:09am EDT

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* CRB commodity index up over 10 pct vs flat global equities

* Futures market structure also boosts commodity returns

By Eric Onstad

LONDON, April 17 (Reuters) - Money is flowing back into commodity investments this year as the sector has broken out of lock-step with other asset classes and outperformed them, attracting investors who aim to diversify portfolios.

After $50 billion of net redemptions in 2013, total inflows so far this year into passive commodity index products and commodity-linked exchange traded funds (ETFs) have amounted to about $5.8 billion, according to estimates by Citi.

Investors are warming to commodities after several years of poor returns due to lacklustre demand for raw materials and as markets moved in tandem in response to economic crises.

Stronger performance on commodity markets this year, after being outshone by stocks over the past two years, has helped thaw investors' interest.

"We have seen persistent flows of money coming into the (commodity) space," said Guy Wolf, global head of market analytics at broker Marex Spectron.

"We have seen a significant change in flows since Jan. 3 of this year - indicative of asset allocation decisions."

The inflow has occurred despite difficulties for some funds, including the loss of nearly a quarter of the assets at the largest commodities fund run by Armajaro Asset Management and several high-profile fund closures last year.

Commodities have been the top performing asset this year, outshining bonds and equities.

The 19-commodity Thomson Reuters/Core Commodity CRB Index is up 10.6 percent this year, exceeding a 4.3 percent rise in the benchmark 10-year U.S. treasury and 0.3 percent increase in the world MSNI equity index.

That represents a major reversal from the surge in world equities over the past two years of 33.6 percent versus declines in commodities of 8.4 percent.

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Asset performance 2014: link.reuters.com/gap87v

Commodity performance 2014: link.reuters.com/reb25t

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PORTFOLIO DIVERSIFIER

Commodities are not only blazing their own trail versus other financial markets, but they are also becoming more sensitive to supply-demand factors, and volatility is increasing.

"Investors appear to be taking commodities more seriously as a portfolio diversifier," Citi analyst Aakash Doshi said in a note.

"Positive correlations with traditional asset markets have unwound, and commodities have lost their tight negative correlation with the U.S. dollar."

Investors flooded into commodities during the boom years up to 2008, attracted by high prices driven by Chinese demand and the fact that the sector had low correlations to other markets.

Following the global financial crisis, commodities were buffeted along with other markets by factors such as central bank stimulus and the euro debt crisis. Those effects started to taper off last year.

Since the beginning of this year, the six-month rolling correlation of commodities and equities returns has averaged 23 percent, the lowest level since the onset of the global financial crisis in 2008, according to Goldman Sachs.

The inflow into commodities has resulted in a huge increase in fund length across U.S. commodity futures markets, based on data from the Commodity Futures Trading Commission.

Managed money net long positions account for almost 20 percent of total open interest, double the average level of exposure of the past five years, according to Barclays' analysis of the data.

Barclays said a survey of hedge fund managers and institutional clients at a recent commodity conference it held in New York confirmed the swing in sentiment.

Over the next 12 months, 54 percent of those surveyed expected to increase their exposure to commodities, while only 12 percent planned to cut. This compares with 27 percent who had raised exposure during the previous 12 months, equal to the percentage who had scaled back.

FUTURES STRUCTURE BOOST

Returns also are rising as more commodities futures move into backwardation, in which nearby prices are higher than forward ones, usually indicating supply shortages.

This means longer-term financial investors get a built-in boost by rolling positions forward, as opposed to a drag on returns in the opposite contango structure.

"One no longer needs to be bullish on commodities, (because) the curves are offering a roll yield," Wolf said. "For the bulk of the period in the investment wilderness, commodities have been fighting a negative roll yield."

There was still a note of caution, however, about commodities among some investors.

While investor interest has increased, not all investors are committing to making the plunge yet, said David Hemming, a commodities portfolio manager for Hermes Fund Managers, which manages 26 billion pounds ($43.7 billion) of assets.

"There has been greater investor interest in commodities this year, particularly in the grains complex," he said.

"We are hitting the point in the economic cycle where we should start to see stronger economic growth from developed markets and usually implies higher commodity market returns." ($1 = 0.5955 British Pounds) (Reporting by Eric Onstad; editing by Jane Baird)

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