Investors bail out of commodity funds

The past few months have been a bad time for commodities: after another round of falling prices in July, 18 of the 22 components in Bloomberg's Commodity index are technically in bear markets, meaning a slump of 20% or more from highs. But it's been even worse for many of the hedge funds that trade them.

Investors are pulling billions of dollars out of the sector after growing tired of persistent poor performance. Several high-profile funds are set to close, including one from Armajaro Asset Management the firm founded by trader Anthony Ward, who was dubbed 'Chocfinger' by the press five years ago when he purchased 7% of the world's cocoa crop as part of a bet on rising cocoa prices. Other casualties include funds run by Cargill, the world's largest grain trader, and one backed by private equity giant Carlyle Group.

It's an abrupt turnaround from a few years ago, when money was flooding into this part of the market. Assets under management at commodity hedge funds peaked at over $28bn three years ago, according to data firm Hedge Fund Research. Years of strong returns in the early part of the 2000s had convinced many investors that these funds were a vital addition to their portfolios and could add both strong returns and valuable diversification.

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Unfortunately, the reality has proved disappointing. After posting eight successive years of positive returns from 2000-2007, commodity hedge funds have only made meaningful gains (on average) in two years since 2008, according to futures broker Newedge. Three of the last four years have seen losses.

In theory, the commodity collapse isn't a problem for hedge funds: they can take a bearish view (bet on falling prices) as easily as they can be bullish (bet on rising ones). But in practice, most managers seem to have a bullish bias. What's more, "this year, even those with bearish bets have struggled due to the high volatility, which has made holding on to long-term core positions difficult", notes Emiko Terazano in the FT.

In other words, far from being trading geniuses who could deliver positive returns whatever the conditions, most commodity hedge funds were simply betting on rising prices using leverage (borrowed money). Once commodity markets fell apart, so did their trading strategies. Investors are finally waking up to this only a few years and some substantial losses too late.