Commodity fund managers face an uphill struggle persuading investors to return to the unloved sector after an abject year in which just two actively managed funds in the 122-strong Lipper Global Commodity group made money.
Although a pick-up in economic growth is expected to boost demand this year, some commodities will remain hobbled by oversupply, making 2014 a crunch year for managers who need to convince investors the asset class can deliver.
"We are still slightly underweight," said Tom Becket, chief investment officer at UK-based Psigma Investment Management, which builds bespoke portfolios for its clients. "We don't have a huge amount of conviction that a turning point is imminent."
The S&P GSCI, a popular commodity index, fell 1.2 percent in 2013, but the average actively managed fund in the Lipper Global Commodity sector lost 9.98 percent. Lipper is a Thomson Reuters fund research company.
Only two of the 122 Lipper commodity funds generated a positive return—the first-placed Credit Suisse Commodity Access Strategy Fund, which gained 3.34 percent in 2013, and the specialist SafePort Strategic Metals & Energy Fund , which returned a marginal 0.09 percent.
Some of the worst performers were hybrid stocks and futures funds, dragged down by natural resource equities. Gold miners fell 53 percent on average last year.
The best performers tended to be long/short or market-neutral funds, as these were able to make money in falling markets and limit downside risk.
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Managers had different theories as to why decent commodity performance proved so elusive in 2013.
"Over the last couple of years, if you invested in commodity indices you lost money," said Mikko Heiskanen, portfolio manager at Pohjola Asset Management. His OP Commodity Fund returned 1.3 percent in the fourth quarter, earning fourth place in the Lipper league table.
"The volatility that comes with that is high and it adds a lot of risk to your portfolio, even if it's just a small holding. So an exceptional amount of money has been taken out of the commodity space, which doesn't help," he said.
A steady stream of redemptions took its toll on a commodity hedge fund sector already battling losses, leading to some high-profile closures in 2013, such as Higgs Capital, Arbalet Capital and Clive Capital.
But Nelson Louie, global head of commodities in Credit Suisse's asset management business, thought the reallocation of money into areas such as equities had had less impact on performance in the fourth quarter.
"The major commodity indices were up 1-5 percent in H2 2013," he said. "Most of the negative performance really took place in the first half of the year as global GDP troughed and various economies were trying to gain some traction."
Losses in the first half were so deep, however, that few commodities ended the year in positive territory—niche offerings such as cocoa, cotton and soybean meal fared best. Among the more liquid commodities, only crude oil and natural gas performed well.
"Commodities have come back down to more attractive prices," Becket said.
Louie is more positive about 2014, as the trend points to an improvement in global growth. Barclays economists forecast global GDP rising by 3.4 percent this year, up from 2.9 percent in 2013.
"Economic indicators continue to improve, credit conditions are better, sentiment is up, housing prices and financial markets are up and central banks generally continue on their paths of easy monetary policy," Louie said.
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Psigma's Becket sounded a note of caution, saying an improvement in commodity prices was more likely to occur in the second half along with confirmation of the growth trajectory and increased confidence about the long-term economic outlook.
"In the short term, that is still quite questionable," he said. "There's quite a bit of complacency with regard to the economic outlook and I wouldn't be surprised to see one more selloff before things start to improve."
The supply picture also presents challenges, Heiskanen said. One reason why investors avoided commodities in 2013 was concerns about new supply coming on stream, especially in industrial metals.
Sustained low prices have prompted mining companies to curtail production and shut unprofitable lines, however.
"Western producers have started to cut capacity over the past year in metals like aluminium and nickel. This is helping to stabilize sliding prices. We've seen prices at levels where a lot of producers weren't profitable," he said.
Unfortunately for investors, the cutbacks in production growth will take two to three years to filter through. "This is not really a theme for 2014 but we are probably closer to the bottom now than we were a year ago. The risk/reward is much better skewed to the upside," Heiskanen argued.
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He attributed some of his outperformance in the fourth quarter to lead and nickel positions, but the bulk of it came from underweighting or shorting gold. He remains relatively positive on industrial metals but is cautious on precious metals and gold in particular.
Bullion prices fell by 28 percent last year, but rallies in the second half kept futures managers on their toes.
"Gold is very volatile because there is a huge amount of short interest," he said. "I think we will continue to grind lower but see snapbacks when the short interest becomes too high and people get a bit nervous over short-covering rallies."
For the asset class as a whole, Louie believes the environment is improving as cross-commodity and cross-asset correlations decline. "We expect individual commodities to be increasingly driven by fundamental supply/demand factors rather than macroeconomic headlines," he said.
But fundamentals will also have to become more supportive if price performance is to pick up. "Generally the asset class is a bit unloved at the moment," Heiskanen said.
"Once we establish a base and see some prospects of tightening in these markets, commodities can do reasonably well over the medium term."