New Year rallies have become so commonplace for commodities that fund managers have almost come to expect them.

Not this year.

Commodities indexes, metals and many other raw materials have seen big losses in 2011 and many investors say the prospect of another year of slack global growth is likely to keep them in cash and other safe havens for some time to come.

"We’re in a bear market, and so our rule is to stick to the highest quality of everything," said Charlie Morris, who manages $2.2 billion as head of absolute return at HSBC Investments (all figures$US).

"We won’t add oil and industrial metals until it’s clear that the macro risks are behind us. 2012 will be a difficult year — with luck we’ll get the low towards the end."

Morris has half his portfolio in cash and bonds and his only commodities exposure is a small position in physical gold of around six per cent. His cautious approach reflects a general wariness over commodities across the fund management industry.

The last few years have seen a consistent pattern of high allocations to commodities as first-time investors have taken the plunge in what used to be an exotic set of assets, and as existing investors increase their allocations.

But 2011 has seen a string of losses. The Reuters-Jefferies CRB index of 19 commodities is down around 10 per cent so far this year, while copper has lost almost a quarter of its value and many soft commodities have lost more than 15 per cent.

The S+P GSCI is almost unchanged for 2011, compared with a full-year gain of over nine per cent in 2010.

Sell-off

Commodities started this year as they ended 2010, with big gains as uprisings in Libya and elsewhere in North Africa cut off some oil supply and raised fears of shortages of other materials.

But a major sell-off in early May hit many markets hard, making wealth managers wary of taking their clients back into commodities, with volatility seen as a problem for investors who want to preserve capital through the global downturn.

"There was a lot of speculative money in commodities and when that came out people thought, hang on a minute, we need to be a bit more careful than we thought," said Rupert Caldecott, chief investment officer of the asset allocation team at Dalton Strategic Partnership, which manages around $2.4 billion.

BlackRock data show non-gold commodity exchange traded products (ETPs) saw net outflows of $1.7 billion in the year to end-November as investors fell out of love with commodities.

Barclays Capital figures show even gold has failed to attract the level of ETP interest that it did in 2009-10.

The prospects for 2012 are, at best, uncertain. Chinese economic growth, a major support for commodities prices in recent years, has slowed in recent months and fund managers are worried the euro zone debt crisis will bring at best a mild recession and at worst a deep depression.

Many investment strategists, including Koen Straetmans, senior strategist at ING Investment Management, are neutral on commodities due to these "tail risks.”

Straetmans is concerned by a slowing of demand growth in China. Any stimulus by China is expected to be low-key as authorities are wary of re-inflating a property bubble or re-igniting inflation, limiting any boost to commodities.

No solution to the euro zone debt crisis has yet emerged and many investors argue only intervention by the European Central Bank can begin to address the issue. Any deal to forge closer EU economic ties would take a long time, they say.

“Wild”

Passive funds also face roll losses from the price structure of many markets that have had a "contango,” where prompt prices are worth less than forward values.

"I am clearly concerned about commodities as a passive investment. I don’t think it’s going to be generating positive returns in 2012," said Pau Morilla-Giner, who runs London + Capital’s Commodities Fund.

While most fund managers doubt how much upward momentum can be expected in 2012, many say downside risks are high, and have fled to safe-haven investments including cash.

Data from fund-flow tracker EPFR Global for the week to Dec. 12 showed investors pulling a net $9.5 billion from equity funds and shovelling $3.2 billion into money market funds.

James Dailey, who helps manage $215 million in assets, including commodities, at TEAM Financial Asset Management in Harrisburg, Pa., sees some merit in what he calls a "Rip Van Winkle" approach to commodities next year.

"If we fell asleep for one year and woke up next December, I suspect prices will be higher and significantly higher from where we at right now in U.S. dollar terms," Dailey said.

"But the path between here and there is likely to be wild."

— Additional reporting for Reuters by Barani Krishnan

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(Reuters) –– Commodity investments could near half a trillion dollars by the end of 2011 as the return of $100 oil and a broad-based rally heighten interest in the asset class to levels not seen since 2008.

But the wave of money now hitting commodities is more sophisticated and discerning than its predecessor three years ago. Investors are increasingly looking for active management rather than “buy-and-hold” plays, which left many counting their losses after the financial crisis hit.

Barclays Capital data and estimates suggest that, if prices remain as they are, total fund investments in commodities at the end of 2011 are likely to be around $420 billion. With any price appreciation, the total would be higher (all figures US$).

Barcap estimated that 2010 ended at a record high of about $360 billion invested in commodities by funds — a year-on-year increase of around $90 billion. Of that, about $60 billion was down to flows and the rest due to price rises.

“The overall environment remains positive, but we would expect to see a slowdown in momentum slightly as commodity prices have increased a fair bit over the course of last year,” said Amrita Sen, a commodities analyst at the bank.

“In terms of 2011… lower than or around $60 billion (in new inflows) perhaps, but a robust number nonetheless.”

Analysts now say half a trillion is within reach as big investors are still keen to allocate funds to the sector.

That number is still dwarved by the size of the global equity market, which was valued at $43.26 trillion as of Monday, Datastream figures show. But it is a huge increase from the roughly $80 billion invested in commodities at the start of 2005, according to Barcap.

Pension interest rising

Asset managers and pension fund consultants confirm they have seen a rise in enquiries and in fund flows.

“We do see a substantial part of our clients both on the private banking and institutional side increasing their allocation to commodities, and we are expecting more fund flows this year from institutions,” said Bas Peeters, head of structured investment strategies at ING IM, one of the world’s largest wealth managers.

Simon Fox, principal of the alternatives boutique at pension fund consultants Mercer, paints a similar picture.

“We have done over 20 commodity future searches (in 2010) and 10 have been in the active space — either for commodity fund of hedge funds or long/short commodity managers,” he said.

Active indexes largely outperformed the standard industry benchmarks in 2010. The Summerhaven Dynamic Commodity Index and the Credit Suisse Glencore Active Index Strategy both returned more than 20 per cent.

The S+P GSCI, meanwhile, returned just nine per cent, and the Dow-Jones UBS Commodity Index 16.8 percent.

Colin O’Shea, head of commodities at Hermes Fund Managers in London, which manages over $1.7 billion in commodities, said UK investors were still under-invested in commodities.

“We have a pretty solid pipeline of new business and we’re talking to investors in the UK, Europe, the U.S. and Asia.”

The return of $100 per barrel crude oil and strong commodity prices last year have piqued interest from investors, Jason Schenker, head of Prestige Economics in Texas, said.

“But everything to do with commodities is going to get more attention in 2011,” Schenker said.

“Investors will be looking at everything from active indices and funds to old-fashioned naked speculation… The longer-term trend is higher, and that’s stoking interest across the board.”

Fund managers say there has been growing interest in enhanced indexes and active strategies due to the disappointing performance of passive investing in recent years.

Mandatory

Huge gains in commodities in the first seven months of 2008 turned into huge losses as markets crashed. Then during the recovery, returns were well below spot price increases due to the structure of the market.

Mercer’s Fox said the shift to active strategies was well underway last year and is likely to continue through 2011. He is now starting to see more interest in timberland and agriculture.

“These give you some exposure to commodity prices but also a return on capital from financing the production of the commodities, and I think that’s where we will see more searches in 2011,” Fox said.

According to Sabine Schels, commodity strategist at Merrill Lynch Bank of America, “The big drivers last year were precious metals and agriculture. We think this year we will move towards more cyclical commodities sectors like energy and base metals.”

Alex Moiseev, chief investment officer at Dighton Capital Management, a managed futures investment manager in Switzerland running around $230 million in assets, said he expected established investors to increase their allocations to precious metals this year.

“For the big insurance companies and pension funds it will become a mandatory asset class to hold. I also see an increased allocation to agriculture, and possibly energy,” Moiseev said.

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