‘The perfect time’ to invest in commodities

It may be time to add the glitter of gold or the sweetness of sugar to your clients’ portfolios. Returns for commodities have been hovering around 20 per cent for the past year and some predict that this is a lasting phenomenon. The only question left for private bankers, it seems, is how much to allocate and which instrument to use.

Philipp Vorndran, chief investment strategist at Credit Suisse Asset Management, recommends that high net worth investors commit a full 10 per cent to commodities.

There are, he outlines, five ways to do this. Firstly, direct exposure via commodities futures and options, which “is regarded as speculative but in fact it’s no more risky than futures and options on equities or fixed income”.

Geneva-based Pictet favours a tactical asset allocation approach. For example, according to Yves Bonzon, chief investment officer of the private bank, it made a strategic investment in January in agricultural commodities, and took a profit of 10-12 per cent only a couple of months later.

Secondly, index funds and ETFs. Mr Vorndran explains: “The advantage of this route is that it is available in different currencies, rather than just US dollars.”

The four main commodity indices are the Goldman Sachs Commodity Index, Dow Jones AIG, CIB Index and Jim Rogers. CSAM runs an index fund on the GSCI.

Mr Bonzon cautions against putting money into an index-tracking commodities fund “and just sitting and doing nothing”. This approach is very popular at the moment, but inappropriate for “such a diverse asset class”. Instead, he recommends hedge funds, which allow investors to benefit from long or short positions. “At the moment we think some base metal commodities are overvalued fundamentally,” he says. “This is a space which gives a lot of opportunity by not just being passively long in commodities.”

Mr Vorndran agrees that the asset class is diverse. In particular, he warns investors to remember that “commodities is not all about oil”. Indeed a dramatic rise in oil prices could negatively impact other commodity prices because of its impact on real demand from developing markets.

Mr Vorndran’s third way is commodity stocks: “You can either invest in companies involved in a broad range of sectors or firms specialising in energy, mining and so on.”

Pictet advocates this approach. “Commodity producers are definitely good holdings,” says Mr Bonzon. A producer, he points out, has the advantage of generating cash flow, “whereas the underlying commodity is just a commodity”.

Tailored mandates

A fourth route, according to Mr Vorndran, is tailored mandates, which are suitable for individual investors only in cases where their portfolio is large enough to justify treating them like an institution.

Finally, investors can access commodities through structured products offer capital protection. However, this may not be appropriate for all investors. Scott Campbell, chief executive of Cape Town-based boutique Optimal Asset Management, says: “We think this market’s going to go up and up, so there’s no need for protection, although it might be suitable for more cautious investors.”

Under the European Union’s new Ucits III directive, a sixth option is now possible. The directive allows a fund investing directly in commodities to be made available to smaller investors. Axa Investment Managers claims to have launched the first Ucits III-compliant commodities product, the EasyETF GSCI.

This could kick off greater investment in the commodities market, which, despite its turnaround in 2002, has so far remained marginal. Mr Vorndran attributes this to a lack of investment vehicles, a dearth of research capabilities and debates over whether commodities could be categorised as a true asset class.

All this is changing and he argues that the perfect time to increase or begin an allocation to commodities could be towards the end of this year, when he expects prices to fall before continuing to rise. The Goldman Sachs Commodities Index showed an increase of close to 23 per cent for 2005, at the end of July.

Mr Campbell, too, is confident. “You still get a lot of price movement in this market,” he says, “but this year our commodity investments are up 20 per cent and we are looking for at least the same next year and for 15 to 20 years to come.” Multi-management boutique Optimal runs $80m and Mr Campbell allocates 25 per cent of its investments to commodities.

Commodity prices have shot up in the past two years. Two years ago a barrel of oil cost $20 (?16.6). At the start of September, it was almost $70. Mr Vorndran anticipates a correction when the price hits $75, in the short term, but over a three-year time horizon he would not rule out prices of more than $100.

Similarly, gold was worth $200 an ounce a year ago but reached $450 an ounce at the end of the summer.

And Mr Vorndran remains optimistic, regarding commodities as “neck and neck with equities as the most interesting asset class for the rest of the decade”.

Vorndran: commodities not all about oil