(The opinions expressed here are those of the author, a
columnist for Reuters.)
By John Kemp
LONDON, April 2 Investors are turning their back
on commodities as returns from futures, options and other
derivatives fail to live up to expectations.
They heyday of commodities as a separate "asset class"
appears over. In future, growth will be concentrated in physical
arbitrage strategies, where trading houses and the trading arms
of energy companies and utilities rather than banks and hedge
funds have an advantage.
Banks tend to blame increased regulation and compliance
imposed on them following the financial crisis for the reduced
profitability of their commodity divisions.
There is some truth in that. But the bigger problem is that
growth in commodity trading has stalled as investors struggle to
Following a large inflow of funds into the asset class
during the boom of 2004-2008, and then again during the Great
Reflation of 2009 and 2010, investors have pulled back.
Pacific Investment Management Company's Commodity Real
Return Strategy Fund, the largest investment vehicle in
commodity derivatives, has seen its assets under management
shrink 25 percent to $14.3 billion from $19 billion at the end
of March 2011.
Schroders Alternative Solutions Commodity Fund has seen its
assets halve from almost $5 billion in August 2011 to $2.6
billion at the end of February 2014.
California Public Employees Retirement System, one of the
earliest evangelists for allocating investments to commodities
as a separate asset class, has cut its exposure to just $2.4
billion from more than $3.5 billion in early 2012.
Pimco, Schroders and CalPERS are some of the best-managed
commodity funds in the business, yet all three recorded losses
in 2013, underscoring just how difficult the environment has
The downturn extends across the sector. Net long positions
controlled by index-type investors in commodity futures
contracts have fallen from $220 billion in January 2011 to $177
billion in January 2014, according to the U.S. Commodity Futures
Investors' diminished appetite has cut deeply into the fees
and other trading income available for the major investment
banks and dealers.
The average commodity fund lost more than 8 percent of its
value in 2013, compounding losses of 3 percent in 2012 and 7
percent in 2011, according to an analysis of Lipper fund data.
Major market benchmarks like the Dow Jones-UBS Commodity
Index and the Standard and Poor's Goldman Sachs
Commodity Index have been flat or falling for three
In a market where the spot price of most commodities has
been stable, investors have not been able to earn enough return
from taking on risk to cover the cost of storing and financing
"Facts and fantasies about commodity futures", the 2004
research paper that popularised commodities as an asset class
for a wider group of investors, promised an equity-like
combination of risks and returns, as well as protection from
inflation and diversification of a portfolio consisting of
stocks and bonds.
But returns have proved disappointing. Commodity indices and
hedge funds have lost money even as equity markets hit new
post-crisis highs. The only diversification has been negative.
Protection against price rises has also come to seem less
important as aggressive unconventional monetary policies by the
major central banks have failed to spark inflation.
Waning enthusiasm for commodities therefore comes as no
surprise, but it has been very painful for banks and hedge funds
that rely on dealing and making markets in commodity
derivatives, as their pool of potential business shrinks.
Interest has now shifted away from financial strategies
based on futures, options and index swaps to physical market
strategies that try to exploit small price differences related
to the delivery time, location and quality of raw materials.
Physical arbitrage is the core business of trading firms
like Vitol, Glencore, Trafigura, Mercuria, Cargill and Noble,
which have correspondingly been able to expand their operations
at the expense of the banks.
But it is much harder for general financial investors to
capture returns from physical arbitrage since it demands much
more specialist knowledge and close relationships with both
producers and consumers.
Even if some specialist funds promise to use their deep
industry expertise to generate arbitrage-related performance,
investors often struggle to prevent the fund managers and
traders from appropriating all the returns.
Banks too lack the economies of scale needed to exploit the
ultra-thin margins in the arbitrage business.
The shift from financial to physical trading has therefore
left banks, hedge funds and mutual funds struggling to generate
acceptable returns and haemorrhaging their best traders and
dealmakers to the trading houses and energy companies.
Market forces are shifting talent and capital to
institutions and strategies that can employ them more
Bank executives like to blame regulators for driving the
business away with intrusive and expensive new rules.
But the underlying dynamics of the business have changed in
ways which have pushed the banks and hedge funds to the
sidelines and seem likely to keep them there in the short term.
(Editing by William Hardy)