* Traders’ ability to move quickly attractive to funds
* PE targeting 20-30 percent returns - source
LONDON, Oct 28 (Reuters) - Funds are taking large stakes in new, smaller, metal trading houses because they see potential for lucrative earnings in the sector, which investors had ignored due to poor returns.
The attraction of small trading outfits is their ability to move quickly when a profit-making opportunity appears and to trade typically in both physical and paper markets.
They can also take stakes in companies with high-quality assets, should cash be needed, and use offtake deals - an agreement to buy future output.
Among the new start-ups are Hartree, where private equity firm Oaktree Capital has a large stake, and Concord Resources, backed by commodities-focused Ospraie Management.
Surprisingly, these investments come at a time of low prices for industrial metals such as copper and aluminium , which hit 6-1/2-year lows in January this year and November 2015 respectively.
The metals industry is gathering in London for LME Week, with volumes on the London Metal Exchange tumbling as commodity markets struggle to emerge from a global slump.
The main driver of lower raw materials prices is a slowdown in economic and demand growth in top consumer China - behind the supercycle that ran from 2002 to 2011 - as the country aims to transition its economy away from manufacturing towards services.
Hartree Partners, founded by former Goldman Sachs energy traders, expanded into metals with a handful of traders in 2015.
“Hartree is a long-term investment for Oaktree Capital, they are probably looking at metals and mining from a distressed angle, getting ready to jump in when valuations come down,” a source close to the company said.
“They may accept lower returns to get in, but eventually they would be looking for numbers near 20-30 percent.”
Meanwhile, Concord Resources, which started to trade in January and has 36 employees globally, is on track to sell just below 1 million tonnes of refined metals this year.
This compares with volumes of 5.2 million tonnes of non-ferrous refined metals traded by giant trader Trafigura in 2015, which retains a market share of 20-22 percent.
Dwight Anderson, founder of Ospraie, said larger trading firms had lost their appetite for smaller deals and “created a market opportunity for people who are customer-service focused, client-focused on small tonnage”.
PREPARED FOR RISK
Most of the new trading shops are run by ex-management teams of larger merchants such as Noble, Gunvor and Mercuria, which have decided to focus on higher-margin commodities such as oil where volatility is rife.
“The downsizing of major trading houses means that new entrants won’t need to build new trading teams, they can use the veterans’ knowledge and connections,” said Richard Jakob, client partner metals, at recruiter Commodity Appointments.
Investors prepared to consider metals and accept higher counterparty risks in the sector, which many firms and funds have abandoned, could reap rich rewards.
“As a fund you can effectively borrow at zero and capitalise or lend to a physical metals trading company and earn 11-12 percent,” said Phillip Price, CEO at advisory firm Ferrometrics. “That’s a very nice return compared with something like government bonds.”
The yield on U.S. 10-year Treasury bonds is less than 2 percent, while that on 10-year German Bunds is less than 1 percent.
Also helping the newcomers are banks exiting metals, partly because of new regulations limiting their activities in physical markets.
Private equity and hedge funds’ appetite for commodities and commodity assets - from copper mines to oil tankers - is not new, as this has always been deemed crucial information that can be used for punting in the futures market, and also as a means of diversification away from public equities.
However, during the so-called commodity super-cycle, when crude oil was above $100 a barrel and copper touched $10,000 a tonne, credit costs for private equity entities were exorbitant and often unmatched by profitability.
Reporting by Clara Denina; Additional reporting by Pratima Desai; Editing by Veronica Brown and Dale Hudson
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