Choosing Commodities: Why the majority of investors still go passive

12th January 2011

The latest report from the Investment Management Association shows that commodity fund sales are currently running at their highest level on record. They sold £208m in November alone. Investors have been lured both by the prospect of another bumper year as emerging market demand rises and also by the threat of inflation, against which commodities offer some protection.

A case can be made either way for investment in commodities, but for investors wanting to gain exposure to their potential growth, the key issue will be whether to take an active or passive approach. This has been under discussion on Schroders Talking Point this month, which makes the case for an active approach.

At the moment, this is the exception. As this FT article shows, the majority of investors still take a passive approach to commodities investment in spite of the relatively strong performance of active managers in this area. However, there are signs – particularly at the institutional end of the market – that this is changing.

Schroders makes the point that passive investments do not always track commodities prices effectively. The use of rolling futures contracts can distort the overall price achieved, leading to significant long-term differences in price. Investors are vulnerable to being buffeted by the caprices of speculators, which are particularly numerous in commodities trading. Arbitragers can take advantage of the predictability of passive money. 

That said, a passive approach does have its advantages. It is cheap, liquid and easily accessible. Investors can gain access to almost any commodity, or basket of commodities they choose. Page 17of this report shows the range of commodities ETFs available and the weight of money that backs them: . There has also recently been the emergence of ‘intelligent' passive approaches to commodities investing, as highlighted here

An active approach will often depend on the skill of the fund manager. If he picks well, a commodities company will often perform better than the underlying commodity. It may be able to mine more efficiently, or leverage its position, or it may have a strong distribution network. However, the reverse is also true – a weak manager may pick companies that do worse than the underlying commodity through poor management or bad risk controls, for example.

 This piece examines the arguments for active and passive investments, many of which apply to the commodities markets. It concludes that a portfolio should include both types of investment – each trying to do a slightly different thing.

One thing is clear – active commodities funds do not tend to be ‘quasi-passive' as is the case with many equity funds, so at least investors do not have that risk. Passive commodities vehicles tend to be blown about by fund flows and, as such, investors should be prepared for a rougher ride. As ever, there are advantages to both approaches and investors need to decide the type of risks they want to take.

21 thoughts on “Choosing Commodities: Why the majority of investors still go passive”

  1. Anonymous says:

    I got my annual premium review letter in from an insurance company that provides income protection.  It noted that the year ending in April 2011, the General Index of Retail Prices had increased by 5.206%.  As I have index linked benefits and premiums my premiums I’ll see a significant increase.

    My first responce was Ouch, is inflation realy as high as that.  Then Ouch, is that realy what the premiums will be.  Then Ouch, I’d get a bigger income rise this year if I wasn’t working than I’ll get from working.

    That reduction in my real world discretionary purchasing power hit home to me and I suspect I’m not the only one to have had that experience recently in other ways.

    1. Drf says:

      Hi Ladydog: you seem to be confirming Shaun’s observation today “The problem I do not not hear them analysing is that we are where we are
      partly because of its past efforts in this area. It does not seem to
      have done much for economic growth but certainly contributed to
      inflation, is that what they want more of?”.  It seems more and more people are slowly coming to realise this; it is just that it takes many a long while to wake up!

      I feel Jeff Randall summarises the general position in an article in the DT: .  Although of course this is related to the USA specifically the same constraints and outcomes are applicable for the UK, as they are always ultimately for all economies. People like Branchflower together with all those with pronounced left-wing ideologies will never understand there things however.

      Ultimately regardless of any entity’s scale only the real wealth possessed may be spent. “Live today – pay later” in the longer term cannot work, but politicians find that too difficult to understand!

    2. Anonymous says:

      Hi ladydog and welcome to my blog.

      I have worked in what is called the regulated world – an odd name as I was regulated before that and the regulator had the initials FSA too- and am aware of how income protection works.

      I guess when the product options were set somebody looked at a chart/graph which told them that wage inflation usually exceeds price inflation. So they could provide what appeared to be index-linking but wasnt quite and would accordingly be cheaper… Reality being inconvenient as it sometimes is will be likely to give them a few more years of the reverse where price inflation exceeds wage inflation.

      As my old knowledge reminds me you need to be careful with the numbers as you can only have the protection up to a certain % of your actual earnings…

      As to a reduction in purchasing power it is happening right now in many parts of the world.

  2. JW says:

    Posted similar things last year. The western world has brought forward growth for at least a decade by over-leveraging debt. Now everyone is trying to de-lever that debt. Whislt the debt is high the economic growth will be absent. Governments only solution is to try to inflate away the problem. Unfotunately the debt mountain is so high this probably wont work fast enough because of compounding. Also private individual de-leveraging hasn’t really started yet. The result is general drop in living standards of about 20-30% over the next ten years. Which is inevitable as ‘globalisation’ forces averaging with developing nations.

  3. James says:

    There seem to be three very difficult things colliding here:
    1. Governments don’t get re-elected if people feel poorer than at the last election;
    2. There is a complete lack of honesty and/or understanding in public discussion about the debt levels, both the absolute level left by the last government and the continuing deficit of the current government. Hardly anyone I know actually realises that we are still borrowing £500 million extra a day and that government expenditure is up over last year;
    3. Special interest groups are unbelievably good at protecting their interests in a way that catches the public eye.
    The result is that:
    1. There is no ability of governments to discuss the issues rationally;
    2. Almost any response is better for them than admitting the truth, that we are poorer than we thought;
    3. The debt level is so high that it can only be brought under control by one or more of outside intervention (as in Greece), inflation (UK), tax rises (UK and PIIGS) or growth;
    4. It is extremely difficult to produce growth given the extreme fiscal deficits already being run.

    So, we end up with the worst of all worlds – stagflation here, debt death spirals in Greece etc, complete stand off (USA), QE (everywhere that can get away with it), with absolutely no effort to bring government expenditure into line with taxes anywhere.

  4. charlie pascoe says:

    On uk agricultural output, it is probably worth noting that the annual harvest is just getting underway. Millions of acres of grain and oil seed will be harvested this quarter.
    In todays trade & futures markets maybe it matters not, but I would have thought that this 3rd quarter is the time when £billions will change hands down on the farms.

    1. Anonymous says:

      One of my inflation benchmarks is supermarket own brands of English butter. Less than a year ago it cost 85p (in a couple of outlets 75p but I’ll ignore that!). In the meantime it has gone to 95p, 110p and now 127p. So one of my basket items that makes up KPI (Kit’s price index) has inflated by almost 50%.
      I am aware that some products are used as customer bait (this does not invalidate it for KPI purposes). However I would like to know if the producers have seen any benefit from these price rises or will we see increased retail profits together with further compromised UK dairy industry?  

  5. Lawrenceofarabia says:

    I am not sure where you’re getting the 3.1% agricultural figures from, in that is the number supposed to be a representation of total product output, or finical income? In the case of the latter, here are the statistics from N.U.F for the total end of year incomes of farmers 2005 £5.1 bil, 2006 £5.2 bil, 2007 £5.7 bil, 2008 £7.6 bil,2009 (preliminary) £7.2 bil. 

    In June the echo chamber that we call the media were regurgitating the headlines of drought conditions in South Lincolnshire and so predicting failing crops; we drove to the area to take a look for our self’s. The soil was moist showing not signs of dehydration or structural fatigue, all seed crops were a lush green giving an indication that there should be a bumper harvest this year if it doesn’t start snowing.

    One can only hope that the close relationship of Murdoch’s WSJ and the good old commodity boy’s is brought into the public domain, and that rumors spread unquestionably by other media outlets (“failed Crops”, “raising frequency of bad weather”, “reducing capacity in food production”) slowly comes to an end. There’s plenty of land, coupled with self interest groups.

    I’ll see if i can dig up the product outputs for you.          

    1. Peter Holmes says:

      It might be worth while also looking at the impact of the Environmental Stewardship scheme (which is a new name for the old Set-aside – only voluntary). Due to demand from applicants Defra held back a number of Higher Level Agreements, and these were due to come into force in April 2011. The gross figures are not enormous, but they would have a negative effect on Agricultural Income if the ONS is quoting actual outputs, rather than farmers’ incomes.

      1. Lawrenceofarabia says:

        Sounds a reasonable assumption that the ESS would have had the effect of output falls of the 3.1% quoted here. Lets hope the present government supports our farmers, and allows us to continue the ability to grow our own food so that we can still feed ourselves.

        All the mamby pamby’ers “EU trade tariffs harming African farmers….” should understand that there is widespread land consolidation happening in Africa, and that the EU trade tariffs are the only thing stopping Tesco et-al outsourcing our staples to Chinese land owners. 

    2. Anonymous says:

      Hi Lawrence

      Thank you I would be interested. The numbers I have quoted are volume ones and showed some odd patterns or perhaps I should say ones I did not expect which is why I asked if others had more expertise in this area than a Londoner like me!

      Agriculture which includes hunting fishing and forestry seems to have been falling in volume terms since 2006 such that on a benchmark of 100 then it is now at 87.4.

      Your next section reminds me of the film Trading Places.

      1. lawrenceofarabia says:

        Hi Shaun, here’s some stats for you.

        “…reminds me of the film Trading Places” Just keeping an eye on the anti-humanist movement aka “environmentalist”, in that if you take their philosophic principles to their logical conclusion, they would like to remove most of the human race. Starting with eugenics, slowly moving up the demographic until there is an Eden Earth. Plato’s utopia is the goal.

        Two future outcomes, de-industrialization with enhanced embedded technology (Elites dream, our grand-children’s death) or a Star Trek type society (our grand-children’s dream)

        Sounds as though i am off my rocker huh?

        One countermeasure, breed baby breed.

  6. Anonymous says:

    Tell me, is there a class of economists or investment analysts or whatever who rather resemble the seers of ancient times who continually pore over data as the seers pored over animal entrails so to predict the future?   If there are, do they have a similar success rate to the magical seers?     I ask because I still can’t grasp that the misbehaviour of two such small economies such as Greece and Ireland  can really have such a disasterous effect on the rest of Europe.   Are they like detonators in a bomb that is Europe?   I can’t imagine this to be so.   I can imagine a few banks blowing up, but so what?   In other words: isn’t the whole thing being overplayed?   Why can’t Greece and Ireland simply be kicked out of the club because they broke the rules?  Why can’t capital that was mistakenly placed simply suffer the risk they took?   It looks like they played a horse which lost and they want their money back.

    1. Lawrenceofarabia says:

      It’s a political process taking advantage of a economic crisis that will eventually lead to further EU integration; in the future a perceived existential threat to all of the independent states of the EU should enable the European elite to fully consolidate political power.

      People who moan about the loss of the nation state remind me of Aristotle who sang the praises of the City state, while Alexander was busy building an empire. The nation state is dying, we’re ending a time of Unionism.      

  7. Zummersetman says:

    When I was driving my car earlier I heard the news about the Q2 growth figures, and I guess I have been reading your blog for so long now, I knew you would have a comment to make about the ONS excuses why it wasn’t a higher figure; and I was right. It is ridiculous to start blaming the warm weather for poor growth, and I am sure I read somewhere that the royal wedding was likely to help growth and not hinder it! And if the takings at my local/ the number of people shopping for street parties were anything to go by then it’s hard to see the obviously massive negative effect this hard on 3 months worth of figures. I wonder how many employees will be able to use the extra bank holiday as an excuse for missing a quarter’s targets?
    It is what it is, and no amount of of BS can put a gloss on the figures. As Gerald Celente often says when he’s having a rant ‘they talk to me like I am 6 years old’. That about sums it up…..    


    1. Anonymous says:

      You might like this sentence which comes from an article on Reuters from last November.

      “The marriage of Prince William to Kate Middleton next year could give a 620 million pound ($985 million) boost to the British economy, retail researchers Verdict said on Wednesday”

  8. Anonymous says:

    I made an earlier point that we are enduring a deleveraging shock with spare liquidity being hoarded by banks or used to fund the deficit. What liquidity that is available is feeding patterns of demand distorted by negative real interest rates away from productive business investment. I agree with James that our total debt levels ( public,household,business and banks) will lead to a very slow burn on growth.

    If there is a QE 3 please let it not be another bank bailout to fund Too-Big-To-Fails’ balance sheets. I’m with Vince Cable that innovation is required to get liquidity to SMEs as the intermediation of capital is a broken system.

  9. Anonymous says:

    On the deal for Greece I think I was not far off in relation to the ecb’s preparedness to accept restructured Greek debt as collateral – I see there is to be enhanced credit support given to the Eurosystem so what the private sector give away the Eurosystem taxpayer pays back in the merry-go-round of socialising losses. 

  10. Anonymous says:

    The private sector debt overhang explains the situation better than the Royal Wedding and the weather.  Households are rebuilding balance sheets by saving and paying down debt.  I should think that as the fear of unemployment rises there will be greater emphasis on increasing cash balances – even in the face of such low interest rates.

    The higher (not high) inflation is eroding the real burden of debt in a practical economical way for people whose incomes are not being eroded in real terms.  That certainly isn’t most households.  

    If Jeff Randall’s sources are right then it is interesting to note the extent to which the public debt driven by the financial interventions to rescue banks and the financial system have contributed to that.

    People often say – never a lender or borrower be – or that there is a gravitational law relating to the level of debt providing a drag on future prosperity.  I very much doubt that this is ever the case. I don’t think anything in economics applies as it may in the natural sciences.  Certainly it will be affected by what the loans are used for. And that has something to do with incentives within the market – distorted incentives if you think that the loans have been used inappropriately.  

    In terms of laws and rules applying as they seem to do in the natural sciences then the rules of capitalism needed to apply to the banking sector: shareholders losing everything and the creditors becoming the new shareholders.  Until bygones are bygones then we’ll carry on like this.   

    1. Anonymous says:

      Hi Sean

      I have argued many times on this blog that we need to avoid Japan’s mistake which was to create zombie banks which put a stranglehold on her economic system for the lost decade. Sadly we have seen so little reform that we are on course to repeat the mistake.

      1. Anonymous says:

        And because there is a wish to sell the assets that have been bought at a profit there is a short term interest – which is over-riding the long term interests of the economy – in only making tentative reforms.  This is besides the effectiveness of the banking sector’s lobbying.

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