By John Kemp
LONDON Dec 19 In a tough landscape for
commodities, most hedge funds and other money managers have
decided to stick with long positions in crude oil, boosting
their investments even as prices slide.
For commodity funds, who must basically be long of something
to justify their continued existence, crude is the
least-dangerous among a series of tricky alternatives.
According to commitments of traders data released by the
U.S. Commodity Futures Trading Commission, money managers' long
positions in futures and options linked to U.S. crude (285
million barrels) are running at almost five times the level of
short positions (59 million barrels).
The long:short ratio has almost doubled from 2.6:1 at the
start of October, and is well above average for the last five
years, though still only half the 10:1 ratio recorded just
before the flash crash in oil markets on May 5 ().
Most of the adjustment has come from the short side, where
funds with short positions in WTI, either outright or as part of
a Brent-WTI spread, have bought them back as U.S. crude prices
Shorts linked to WTI are down 40 percent from 98 million
barrels to 59 million since Oct 4. Longs are up 9 percent from
263 million to 285 million. For the most part funds have become
less bearish on WTI, rather than more bullish, though a few
aggressive traders have been adding to their upside exposure.
The same pattern is apparent in Brent. Managers have taken
profits on their shorts, while adding cautiously to long
positions, as prices have dropped to some of the lowest levels
since February. Fund managers have boosted long positions by 22
million barrels (23 percent) while slashing shorts by 34 million
barrels (50 percent) ().
The persistence of so much bullishness seems odd at first
glance. Political risks linked to Iran continue to offer
support, but the economic outlook is worsening, cutting
expectations about demand next year. And on the supply side,
fears about disruption of Iran's exports are offset by
expectations of improved availability from 2013 onwards as a
result of fracking and other technology developments.
But it has been a rough year for commodity funds as a whole,
as the darkening outlook has snuffed out first-half price gains.
There are signs money managers are becoming more conservative,
focusing on relative value rather than directional trades, with
crude winning a beauty contest among ugly alternatives as the
commodity with the least-worst prospects.
Conservative allocations favour crude for three reasons:
(1) In principle, a commodity fund could be long or short of
commodities as a whole. But most investors have allocated money
to specialist commodity funds because they believe the asset
class will outperform.
Justifying a net short exposure across the portfolio is
difficult. It is even harder if prices rise, and they find
themselves losing money in an asset class to which they had made
a strategic allocation.
Commodity fund managers therefore have no option but to be
long of something. The best they can do in troubled times is to
raise their exposure to cash in a bid to dampen the impact of
market moves on the portfolio's performance.
(2) For outsiders, the asset class is synonymous with oil
and gold, which are the most visible, with prices quoted daily
in the media. Fund managers are under intense pressure to remain
long or at least neutral towards crude.
Most investors may be prepared to overlook a fund's losses
when oil prices are tumbling as bad luck rather than poor
management. In contrast, a manager who loses money when oil
prices are surging is unlikely to survive long. Long positions
in crude futures and options therefore provide "right-way"
exposure to the asset class.
(3) Given the long lead times needed to develop new crude
oil supplies (5 years or more), compared with shorter lead times
in agriculture (1-2 years) or aluminium smelters (2-3 years),
oil is a much better defensive option when the short to medium
term outlook becomes uncertain.
In a prime example of increasing conservatism, the giant
Schroder Alternative Solutions Commodity Fund
has battened down in the face of the storm, boosting its cash
allocation from an already-high 24 percent at the end of August
to 31-32 percent in September and October and more than 32
percent at the end of November.
In the meantime, allocations to Brent and WTI have remained
steady or increased. The result is that crude accounts for an
increasing share of the non-cash part of the portfolio.
The fund's total exposure to energy has edged up slightly,
from 21 percent at the end of August to 23 percent at the end of
November. In contrast, exposure to agricultural products has
been slashed from 34 percent to 23 percent, according to
performance data published on Schroders' website.
The same strategy is being replicated at other funds. As the
outlook becomes confusing, exposure is being pulled back to the
"core" of the portfolio and away from riskier outlying areas.
In a more turbulent environment, the risks of straying too
far from the herd have risen, and managers are sticking with
bellwether commodities most familiar to investors, with the
longest supply lead times to minimise downside risk.