As we’re watching stocks plummet today (along with most of the futures board), we’re not too concerned. Several of the managers we track are doing well today, having positioned themselves for this sell-off. That being said, we’re sure others are feeling the pain, particularly those who have chosen commodity exposure via long-only commodity funds. We posted earlier today on their underperformance relative to purchasing a December futures contract in the indicated market and rolling annually, but that pain has been echoed in an article from Reuters entitled Are commodities at risk of de-financialisation?:

But even before the super-cycle ran out of momentum, passive investors in commodity futures and options were struggling to make money. Returns on the GSCI and its derivatives have been lower than U.S. equities over almost any time horizon since 2000.

Unlike an investment in equities, commodity futures do not provide a stream of dividends. Instead investors have been hit with the cost of storage. Passive index investors have been hit by the reduction in bond rates, which has hit the collateral yield on the safe financial instruments used to collateralise their holdings of commodity futures.

There is also evidence that some commodity markets have become overcrowded, with index investors competing away the risk premium and roll yields that existed before the asset class became fashionable in 2004.

For a time, the surging spot prices for a range of commodities, from crude and copper to iron and cotton, masked the deterioration in underlying performance of the indices. But as the super-cycle gives way to a period of plateauing prices, the problems with a passive long-only exposure are becoming more apparent.

We’ve been saying this as loud as we can for what seems like forever, but the article is not without holes. See, the author functionally concludes that people will turn away from commodity futures altogether, regardless of the wrapper for the investment. But there are other ways to gain exposure (*cough cough* managed futures) that don’t rely on a super-cycle to generate profits. When you can position yourself for up AND down movements, it’s a different story. The article touches on this, but doesn’t quite get it, saying:

The most radical strategy is to allocate funds to a hedge fund with a wide mandate to take long and short positions.

Only the most radical, hedge fund long/short strategy is likely to work on a sustained basis. The others have already begun to compete away the returns to curve optimisation etc as the strategies become more widely adopted.

The problem with hedge fund strategies is that returns are to the skill of the hedge fund manager rather than intrinsic to the commodities themselves.

Those hedge funds are CTAs, and we wouldn’t call the well-established managed futures universe some kind of radical, unknown investment opportunity. Maybe in media spheres, but not for investment professionals (at least, it shouldn’t be). Further, a closer look at the managed futures space reveals a majority of strategies that are not reliant on individual manager discretion, but systematic approaches to trading that take emotion and judgment out of the equation. That doesn’t guarantee a win, particularly if you’re only selecting one manager to allocate to, but part of the benefit of a balanced portfolio in managed futures is the ability to more effectively manage risk.

So, is the financialisation of commodities going away? Well, if that means investors will stop piling into long-only commodity funds that are doomed to underperform on a regular basis, we hope so. But is exposure to commodities via futures a losing proposition? Not necessarily, especially if you’re doing it right.