Institutional Investor's Alpha Magazine - February 2008 - (Page 27)

commodities and basic industries have seemingly disconnected from the balance sheets,” he says. “While we get blamed for a lot of the froth and speculation in the markets, most investors don’t realize that hedge funds no longer represent the truly speculative element in commodities investing — it’s all that long-only money ﬂowing into commodities. It’s monolithic.” Agricultural commodities prices are experiencing a conﬂuence of drivers fueling opportunity. First and foremost are the fundamental, macroeconomic changes now powering increased demand, but — over and above those secular changes — legislative requirements are compelling the adoption and production of biodiesel in the U.S. and Europe. With the threat of a U.S. recession overshadowing the global economy, commodities are beginning to look like one of the only markets where institutions can make money — but the sheer quantity of new capital ﬂowing into commodities is also pushing prices higher. Despite the risk of price shocks, a raft of hedge fund ﬁrms, boutique investment shops and investment banks are developing new means to tap into the rising markets. Some, like Ospraie, are fundamental investors pursuing hedged strategies across a range of diverse investments, trading futures, buying equities and taking stakes in farmland. Others, like Lausanne, Switzerland–based Diapason Commodities Management, an $8 billion commodities investment ﬁ rm, are designing long-only and long-short agricultural funds to appeal to investors looking to make focused bets on biofuel and non–genetically modiﬁed crops. Not to be left out, investment banks like Deutsche Bank and Merrill Lynch & Co. are designing easily tradable commodities indexes tracking agricultural futures, including those for crops used to create biofuel: sugarcane, corn, soybeans, barley and rapeseed. Anderson and his team at Ospraie have been keen to try to determine the size and composition of the overall commodities market. Total open interest — the hard cash invested — in all commodities futures contracts is currently about $600 billion, which is only $150 billion more than the market capitalization of Exxon Mobil Corp. According to Ospraie’s calculations, index money currently represents more than 40 percent of the open interest. “All of that open interest ultimately creates an artiﬁcial demand because it takes inventory away from the markets and drives up prices,” Anderson says. For institutional investors with no preexisting allocation to commodities, the attractions may continue to outweigh the risk that prices will overheat, given the growing threat of inﬂation. The Federal Reserve Board may be pumping money into the global ﬁnancial system to minimize the impact of the subprime mortgage crisis and help thaw out the frozen credit markets, but that only increases the chances of inﬂation spikes. The signs are already ominous. Although economists tend to strip out the costs of food and energy when calculating inﬂation — they are deemed too volatile to be true indicators — consumers know better: the U.S. consumer Photo by Ian Phillips-Mclaren for Alpha price index data released on January 16 indicated that in 2007 the overall cost of food rose by 4.9 percent, the highest annual rate of increase since 1990. The price of groceries rose even more sharply, jumping 5.6 percent. Lionel Motière, co-founder and chairman of Diapason, believes that the world is entering a decade of inﬂation. “We expect to see double-digit inﬂation rates, but inﬂation is not a linear process,” Motière warns. “It often takes all the investors by surprise. So far, we are in the early stages, but if you look at the prices of food and energy — and even if you look at the prices of ﬁnancial assets — we are already in an inﬂationary world.” Investors must now safeguard their portfolios against both falling equity prices and rising inﬂation, and commodities have long been known to afford some protection — not least because they have a negative correlation to other asset classes. According to a 2006 study by Chicago-based Ibbotson Associates, commodities tended to produce relatively high returns in years when traditional assets performed poorly during the period from 1970 through 2004. Last year followed that trend: The total return for the Standard & Poor’s 500 stock index was just 5.49 percent; the S&P Goldman Sachs commodity index’s was 32.67 percent. “Whether the subprime sector melts down or not, people are going to keep buying steak in the grocery store and keep pumping gas into their automobiles,” says Robert Greer, an executive vice president and head of real-return products at Newport Beach, California– based ﬁ xed-income powerhouse Paciﬁc Investment Management Co., which commissioned the Ibbotson study. “Farming is still an activity that requires human capital,” says Stephan Wrobel, CEO of Diapason Commodities Management. FEBRUARY 2008 • INSTITUTIONAL INVESTOR’S ALPHA • 27

Table of Contents Feed for the Digital Edition of Institutional Investor's Alpha Magazine - February 2008

Institutional Investor's Alpha Magazine - February 2008 Contents Letter from the Editor Longs & Shorts Pension Corner: Alternative Perspective The Good Guys: A Simple Plan Cover Story: Energy and Commodities: Fueling Opportunity Regulation: Energy Trading: The Brawl on the Hill Interview: Master of Values Regulation: Hedge Fund Registration: Way Out West Research Center: Top Hedge Fund Analysts Alpha Bytes: Rocket Man Unhedged: Commentary: Structured for Success

Institutional Investor's Alpha Magazine - February 2008

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