As investors pour money into commodities, they’re no longer content to merely buy the index. At the $225 billion California Public Employees’ Retirement System, for example, active strategies make up 25 percent of the Sacramento-based pension fund’s $2.5 billion in commodities investments. “We’re seeing a tremendous amount of interest from institutional investors in fully active strategies,” says Michael Johnson, vice president of commodities portfolio management at Goldman Sachs Asset Management in New York.
As recently as 2005 global institutions placed nearly all of their commodities assets — then worth $73 billion — in passive, long-only strategies, according to Barclays Capital. Last year enhanced index and long-short vehicles claimed $55 billion out of $376 billion. “We’re still seeing strong inflows into passive strategies for diversification, but investors now are looking to generate alpha as well,” says Philippe Comer, Barclays’s New York–based head of commodity investor structuring for the Americas.
Demand for third-party managers is growing. “It is a natural maturation of the asset class,” says Adam De Chiara, co-president of Stamford, Connecticut–based Jefferies Asset Management, which manages more than $1 billion in commodities.
The unique challenges of indexing commodities have helped drive investors toward active strategies. Unlike broad equity indexes, commodities indexes turn over each month when the nearest-term futures contracts expire. Active investors can profit by rolling contracts before or after the scheduled trade. Such roll timing has recently added 30 basis points a year in outperformance, says David Hemming, portfolio manager at London-based Hermes Fund Managers, which invests $2 billion of its $40.1 billion in assets in commodities.
The shape of the commodities futures curve can complicate matters. Starting five years ago, the curves for crude oil and several other commodities became upward-sloping, with longer-dated contracts priced higher than those closest to expiration, reflecting expectations that demand from emerging markets and uncertainty about future supplies will boost prices. When index investors roll from the nearest, cheaper contract to the next, more-expensive one, they lose money.
To combat negative roll yield, money managers buy contracts several months out, where the price curves for many commodities tend to flatten. “I can be away from the immediate contract and roll from the third- to the fourth-month contract to avoid some of the negative impact on returns associated with a futures curve that is upward-sloping,” says Johnson of Goldman, whose firm manages some $4 billion in commodities.
Commodities can be rich sources of alpha, especially compared with equities and fixed income. Consolidated data on commodities is not widely available, says Michael Lewis, who is a principal and works in manager research at Mercer in Toronto. Also, because producers and consumers such as oil companies and airlines still dominate commodities markets and they generally seek to lock in prices, financial players willing to accept price fluctuations can earn a premium for taking the other side of the trade.
One manager with an all-in-one, passive-plus-active approach to commodities investing in a mutual fund format is John Brynjolfsson, CIO of Aliso Viejo, California–based Armored Wolf, subadviser to the Eaton Vance Commodity Strategy Fund. Most of the fund aims to match the Dow Jones–UBS commodity index through a total return swap. Armored Wolf adds an actively managed overlay component that can be long or short by as much as 5 percent of the index.
Brynjolfsson uses active strategies from roll timing and curve positioning to relative-value trades based on geographic or qualitative anomalies. He also makes directional bets on individual commodities. As of mid-March the Eaton Vance fund was up 19.75 percent since its April 2010 launch, versus 20.74 percent for its benchmark. The fund trailed the index partly because of a short-term cash position in the first weeks after inception.
Investment managers and consultants predict that active commodities strategies will become even more popular. “Even if you’re trying to invest passively, you need active management to keep up with the indexes,” says Payson Swaffield, chief income investment officer at Boston’s Eaton Vance Investment Managers.
