Commodity niches lure as markets converge

Tue Jul 31, 2012 9:23am BST

(Adds dropped character in para 1)

* Main commodity indices increasingly track other markets

* Investors seeking diversification look at sub-sectors

* Niche areas more isolated from marco events

* Real assets, OTC energy products, agriculture targeted

By Eric Onstad

LONDON, July 31 (Reuters) – As commodity indices
increasingly track other markets, investors are targeting niches
including timber and other real assets, over the counter (OTC)
energy products as well as agriculture markets with more
insulation from macro-economic events.

When investors piled into commodity markets a decade ago,
one of the main attractions were their diversification
qualities: here was a sector that did not move in line with
equity, bond and foreign exchange markets.

But since the 2008 financial crisis, broad commodity indices
have shown much stronger correlation with other markets,
especially risky assets such as equities, providing less
diversification for institutional investors.

A quarter of investors who cut exposure to commodities said
the reason was high correlation with other assets, according to
a survey by Barclays earlier this year.

Some investors are honing the focus of their cash on real
assets including farmland, timber, mines and energy projects,
which are less correlated to financial markets.

“When we talk to our investors, they talk about the
arguments about the benefits of real assets,” said Daniel
Leveau, head of portfolio management of 1741 Asset Management.

The Zurich-based group, which has 1.8 billion euros under
management, is a subsidiary of Notenstein Private Bank, in turn
owned by Raiffeisen Cooperative Switzerland, the country’s third
largest banking group.

“We’ve seen a lot of demand from private clients who are
trying to protect their private wealth and also on the
institutional side, demand for exposure to an underlying asset
which is tangible.”

The move to real assets and other alternative commodity
investments has occurred as investors withdraw money from
commodity index products with exposure to commodity markets.

Commodity index swaps have suffered $6.5 billion of outflows
so far this year, Barclays said earlier this month, after five
consecutive quarters of outflows.

Simon Fox, a London-based principal at Mercer, which advises
pension funds on their investments, said he recommends exposure
to commodities through real assets rather than index products.

Some 2.3 percent of UK pension funds surveyed by Mercer this
year have exposure to commodity or timber assets, more than
double the percentage in 2008, when it was less than 1 percent.

This expected to climb further in coming years as pension
funds diversify their portfolios away from equities, Fox said.
Mercer advises 873 clients with 671 billion pounds of assets
under management.


Another way to avoid investing in products that move along
with other risky assets is through OTC energy markets, said Guy
Wolf, macro strategist at brokerage Marex Spectron.

“If you are looking for alpha in the commodity world, there
are really only two places you can go. One is the OTC energy
space and the other is agricultural futures.”

Alpha measures the risk-adjusted return of an investment or
the return in excess of a benchmark index.

One reason financial markets have become so interlinked is
through computer trading programmes, but the black boxes are not
able to access many niche OTC energy markets, Wolf said.

So far there have been only tentative moves into these
markets by asset managers, some of which are restricted to
investing in listed markets, he added.

“Attitudes are changing, however, as funds are always
looking for non-correlated liquidity pools. We are doing a lot
of work with some very large funds to research these markets and
provide liquidity analysis as well as execution infrastructure.”

The UK and European gas and power markets will probably be
the first OTC energy markets to attract fund money, Wolf said.

“Assuming you know the fundamentals, you can potentially
make money in pockets of OTC markets where you can be relatively
isolated from whether a Spanish bank needs more capital. I think
people will seek them out a lot more than they have done.”


Within traditional futures markets, agricultural products
are jolted by droughts and floods, often swimming against the
tide of macro events that sway commodities and other markets.

“Agriculture still has nice diversification compared to
equities, so that will remain a nice diversifier,” said Koen
Straetmans senior strategist at ING Investment Management in the
Netherlands, which has 330 billion euros under management.

During the 10 years before 2008, the average correlation
between the SP GSCI commodity index and the SP 500
equities index was close to zero, but during the past
three years it has soared to 70 percent.

The 30-day correlation of the Goldman Sachs agriculture
index to the SP 500, however, is at 20 percent.

Since the beginning of May the GSCI agriculture index has
gained 16 percent as a drought damaged crops in the U.S. Midwest
while the main GSCI commodity index shed 7 percent, weighed down
by worries about the euro zone and global growth.

At Armajaro Asset Management in London, the firm’s flagship
Commodities Fund has seen redemptions this year, but there has
been renewed interest in the group’s CC+ fund, which focuses on
cocoa, coffee and other agricultural markets.

The CC+ fund which has had average annual returns of 12.4
percent since launch in 2007, has attracted interest mainly due
to its lack of correlation to other financial markets, Chief
Executive Harry Morley told Reuters earlier this year.

(Reporting by Eric Onstad, editing by William Hardy)

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