Commodities provide investors with diversification to what one might describe as the ‘building blocks’ of all goods; From the wheat one consumes in bread, to the bits of gold used in electronic components and utility bills linked to oil prices, commodities affect our everyday life in both visible and invisible ways. Despite our house view preferring asset classes which provide investors with cash flows, the global attention drawn to commodities following the meteoric-rise in oil and gold prices over the past few years sees us review the commodity funds for our investors’ benefit.

1. Know The Difference Between Equities & Derivatives

A derivatives-based and an equities-based fund are 2 completely different investment vehicles. For the former, the fund uses derivative contracts specifying delivery of commodities at a specified date in the future for a pre-determined price today, for the latter, the fund is buying stakes in companies which has operations closely related to the commodity. Although the objective of two funds could both be to capture the upside potential of commodity prices, investors need to ascertain how the fund aims to achieve this. The performance of these two funds can differ greatly as commodity-related equities may be affected by factors other than commodity-prices, such as company-specific and equity market events while commodity prices remain constant. For instance, we saw during the equities selloff in 2011 that company’s fundamentals were ignored as equities were sold off en-masse when markets panicked, while gold futures failed to collapse as gold mining equities did.

Given that the commodity-equities related funds on our platform provide targeted and concentrated exposure to individual market sectors, investors looking for more diversified exposure, and, a ‘purer’ commodity play should look towards the commodity-derivatives fund space.

2. Commodity-derivatives Funds: Index-Tracking v Actively Managed

Within the commodity-derivatives fund space lie 2 SGD-hedged funds which provide investors with diversified exposure to ‘pure’ commodity plays: the DB Platinum Commodity RIC-C SGD Hedged and Threadneedle (Lux) Enh Comm Cl ASH SGD.

Key differences between the 2 funds stem from their respective index-tracking and active management styles. The DB Platinum Commodity RIC-C SGD Hedged tracks an index which seeks to exploit the tendency of commodity prices to mean-revert in the medium term, over-weighting commodities which are below their long-term mean and vice versa. In 2011, the whip-sawing of the commodity markets saw the index tracking fund lose -23.9% for the year, a fairly poor performance which highlighted the shortcoming of an index-tracking fund, while its 1 year annualised volatility measured 17.1% (as of end April 2012), showing that it was by no means less volatile than a generic commodity index such as the DJ UBS Commodity Total Return Index which reported volatility of 10.9% for the same period.

TheThreadneedle (Lux) Enh Comm Cl ASH SGD on the other hand, is an actively managed commodities fund which provides investors with diversified exposure across the commodity futures spectrum. With its active management which utilises a fundamentally driven process with a focus on relative value, the fund seeks outperformance of its benchmark (DJ UBS Commodity Total Return Index) by 3-6 percentage points (pp) per annum, a feat which it has easily accomplished in the first year since its inception in July 2010 (July 2010- July 2011), and in 2011, when it delivered returns of 8.7 pp and 12.2 pp respectively. In 2011, the fund lost -5.0%, despite comprehensively beating its benchmark which returned -13.4%. Taking a look at its longer term record, the fund has performed strongly, recording a total return of 28.9% since inception (July 2010) as of end April 2012. In addition, its risk management capabilities saw its 1 year annualized volatility level read 10.7%, beating its benchmark’s reading of 10.9%.

Despite the lack of a long term track record due to its infancy, the Threadneedle (Lux) Enh Comm Cl ASH SGD looks promising based on its strong performance levels (outperformed its benchmark in 18 out of 21 months) and risk management capabilities(low levels of volatility), demonstrating now as the now soft-closed Schroder AS Commodity Fd SGD A Acc did before, that perhaps active management tends to deliver better results for commodity funds.