Alarm over commodity ETP returns

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Investment banks are racing to launch commodity-based exchange traded products after a flood of money entered the sector last year.

However, the move has highlighted concerns that the performance of commodity ETPs can dramatically undershoot that of underlying spot commodity prices, a factor not all investors may understand.

Barclays Capital, Deutsche Bank, Julius Baer, UBS and Amundi, formed by a merger of the asset management arms of Société Générale and Crédit Agricole, launched 45 commodity ETPs in the first two months of 2010, according to figures from Deutsche Bank, compared with 66 such launches across Europe in the whole of 2009. Already this month UBS has listed 69 exchange traded commodities on the London Stock Exchange.

The launches come after assets under management in European commodity ETPs surged 145 per cent to €21.2bn (£18.9bn, $28.8bn) in 2009, according to Deutsche, which forecast further growth of 60-90 per cent this year.

However, investors in these products are, more often than not, receiving substantially worse returns than those of the underlying spot commodity prices.

The discrepancy arises because most of these ETPs, with the exception of some precious metal funds, invest in futures contracts that are rolled over before expiry. When the forward curve is upward sloping, known as contango, investors lose money every time the contract is rolled forward.

The effect of this roll yield can be huge; while the benchmark S&P GSCI spot index has returned 69.3 per cent since the start of 2005, the equivalent total return index, which factors in the roll yield, has produced a loss of 15.6 per cent.

When futures prices are below spot prices, known as backwardation, investors will earn a positive roll yield. However, figures from Deutsche Bank suggest contango is more commonplace.

Roll returns in the crude oil market have been negative every year since 2005, peaking at -61 per cent last year; while spot prices rose 78 per cent an investor would only have made 17 per cent. Roll yields for gold have been negative every year since at least 1989, although the aluminium and wheat markets have been more evenly balanced.

Jeremy Charlesworth, chief investment officer of Moonraker Fund Management, a London-based boutique whose own research points to negative roll yields from wheat, coffee, gold and copper last year, said he was aware of even “sophisticated” investors who failed to understand they would not get the spot returns from the products.

“A lot of wealth managers and IFAs [independent financial advisers] have bought ETFs for their clients for the long term without understanding the potential effect of a negative roll yield,” he said. “They thought they were getting the spot returns and cannot understand where the discrepancy in performance comes from.”

Product providers are attempting to minimise this problem by tweaking their vehicles. Deutsche Bank’s range will buy the futures contract that minimises a negative roll yield or maximises a positive yield. But Rajiv Shukla, head of commodity asset structuring, admitted the funds “don’t come close to spot returns”.

UBS’s range will invest across the curve up to three years out, subject to liquidity. Its crude oil product would have returned 27 per cent last year, it said.

Mr Charlesworth added: “Investors really shouldn’t be buying into ETPs when the market is in contango. Many commodity ETPs are short-term trading vehicles and investors should avoid them if they want long-term exposure to commodities.”

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