Investments in commodities have exploded over the past three years and while investors are feasting on a smorgasbord of funds and products, the sheer number of options in the market is giving many a bellyache.
The new products are so varied and complex that investors need to figure out what works best. While it takes time to learn - and avoid pursuing a flawed strategy - investors also don't want to miss the party.
"Unfortunately, many investors in this burgeoning space leap before they look," said David Krein, president at DTB Capital, a New York firm that gives advice on commodity-linked products and other investment opportunities.
"Once the commodity investment decision has been made, investors are then faced with the prospect of directing their capital into the growing universe of commodity-linked vehicles," Krein said. "This is not an easy task."
Just five years ago, playing the energy, metals and agriculture markets simply meant taking a long position in a handful of commodities futures indexes such as the Dow Jones-AIG, the Goldman Sachs GSCI and CRB (now renamed S&P GSCI and Reuters-Jefferies CRB, respectively).
A long position meant buying and holding over time futures contracts tied to these indexes in hopes that prices would rise. A short position meant selling futures or spot contracts up front with a promise to deliver later, in hopes that the market would fall in time for the investor to make a profit.
While these two strategies still exist, they have morphed into many new ideas. Since 2004, more than a dozen commodity ETFs - exchange-traded funds tied to commodity indexes, individual spot commodities and individual commodity futures - have come into play in the United States alone. The market for such ETFs in Europe is even bigger. ETFs aside, there are ETNs - exchange-traded notes that track commodity indexes. There are also mutual funds that trade off commodity indexes.
Broadening the field are structured investment products in equities and bonds that have elements of commodities, and ETFs of commodity producers' stocks.
While investors certainly want a piece of the action in raw-materials markets, banks and Wall Street firms eager for their share of fees were probably flooding the commodities space with more products than needed, analysts said.
That left investors in a mine field as they tried to pick combinations delivering the right ratio of risk to reward. "The effort to analyse commodity-linked vehicles and make the necessary distinctions between and among them has trailed far behind the product-development cycle and accompanying marketing push," Krein said in a recent note to investors.
But some of the biggest investors in commodities may be taking their time to decide on the newer products. These investors, which include multibillion-dollar pension funds and other pools of public and private money, have yet to see their desired returns from passive investments made in commodity indexes - due to a peculiarity with oil futures.
Oil is a major component in most commodity indexes and investors seeking to hold a long position must substitute expiring front-month contracts with forward months. US crude prices have been mostly in contango since 2004, meaning a higher price in deferred months than nearby. The resulting loss, or negative roll, has disappointed some investors.
Another concern for investors is the diminishing potential for alpha, or gains beyond market expectations, in commodities, as more participants enter the sector and quickly replicate any winning strategy.
Although hedge funds regularly boast of outperformance by combining commodity plays with equities, the implosion of big names like natural gas trader Amaranth has made investors take more time in hiring managers and building portfolios.
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