Hermes: Commodities are Still a Diversifier

(October 28, 2013) – Commodity returns are once again decoupling from equities, displaying the diversification benefits they had shown before the financial crisis, according to Hermes.

The asset manager said that while investors were understandably disappointed with commodities positive correlation with equities during May and June this year, they shouldn’t abandon the asset class as a diversifier just yet.

Jason Lejonvarn, strategist at Hermes Commodities, wrote in a paper that historically, the positive correlation between equities and commodities has been low—averaging 0.2 between 1970 and 2013.

That figure spiked at 0.8 during the tapering tantrum of Q2 this year, driven by widespread “risk-on” and “risk-off” appetites, he said, along with central banks’ asset purchasing programmes and slower Chinese growth.

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But today, the correlation is easing once again. “Commodity investors should not despair. The correlation between commodity and equity returns is significantly lower than monthly data since mid-2008 indicate,” he said.

“Lower correlations are already here. Looking at more frequent daily data, commodity and equity correlations peaked in the autumn of 2011. Since then, they have decreased from approximately 0.7 to 0.4. Meanwhile, commodity and bond returns have had consistently negative correlations.”

Other diversification indicators within the commodity asset class also continue to show positive signs, he continued. The average correlation between the five commodity sectors—energy, industrial metals, precious metals, agriculture, and livestock—have had little to zero correlation, enriching the diversification properties of the asset class.

“Daily returns show that inter-sector correlations peaked in late 2011 and have since declined from a high of 0.42 to 0.1. Commodities are reverting to their historically low inter-sector correlations,” he said.

Another diverse attribute of commodities is its relatively high cross-sectional volatility, rising recently from 15% to approximately 25%. If you’ve got the stomach for it, Lejonvarn said this volatility increase was indicative of positive active commodity returns.

“These recent trends indicate that the diversifying qualities of commodities are on the mend. Like other risky asset classes, commodities suffered high correlations with other risky assets after the financial crisis. However commodities are now reverting back to being a diverse, independent asset class,” he concluded.

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(October 25, 2013) — Institutional investors must challenge board directors of unlisted funds if they are to see an improvement in transparency and governance, a campaigner has said.

Charlotte Valeur, director of the Global Governance Group, told aiCIO that while campaigners were working to encourage improved governance on unlisted funds’ boards, the truth was that money talked and they would be far more likely to listen to investors.

These funds could include smaller, segregated, specialist funds, rather than those pooled funds run by larger, more well-known fund managers.

“We are pushing for the unlisted fund space to give some level of transparency—even just one page detailing the board members, where meetings are held, and what was discussed—that would be start,” she said.

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The drive for these basic pieces of information has come from Valeur’s conversations with large institutional investors, including Railpen and USS in the UK.

“Unlisted funds need to be aware that if they want institutional capital, they’ll need to offer good governance from the start,” she continued.

Examples of poor fund governance were plentiful in the industry, Valeur revealed. Boards with temporary chairmen, boards filled entirely with family members and friends, and directors with more than 200 directorships to their name were all pointed to as examples of bad practice she had come across.

To help in her mission to bring unlisted funds into line, Valeur has appealed to institutional investors to ask five hard-hitting questions of their unlisted funds’ boards.

These are:

1) Ask about the composition of the board. Fund boards should have more than one independent sat on them, be experienced in the industry, and have regular board meetings. Investors should quiz the fund about what is discussed in the meetings, whether summaries are distributed to investors, and whether they meet their auditors separately from their investment managers.

2) Ask what the board processes are—if they meet less than once a year, as if there are little or no formal processes in place that is a good indicator of how seriously they are taking their role. An annual letter describing the board’s practices should be a bare minimum.

3) Ask how many directorships each board member already holds. “If something goes wrong, you need to make sure they have enough time,” Valeur advised. Ask them to disclose any remuneration for the role—if they’re not being paid at all, that could be a warning sign.

4) Determine who has voting rights to keep members on the board. In many cases it’s only the investment manager with the rights, leaving investors powerless to remove poorly performing directors.

5) Ask to speak to them directly. “If they won’t speak to you, you’ve got to question why,” said Valeur.