Real assets in the commodity space look set for a renaissance, given the recent upturn in energy and metals prices and the growing proliferation of co-investments on offer, according to Andrew McCaffery, global head of client-driven and multi-manager solutions at Aberdeen Standard Investments.

That could mark a turnaround in the appeal of a sector that has not enjoyed strong investor support in several years, he noted, and his views are supported by executives from the likes of US alternatives investment giant Blackstone and UK fund house Schroders.

“The real asset space, and commodities in particular, has not been particularly in favour among many institutional investors in recent years, as they have seen the area as a poor-quality or low-return diversifier,” London-based McCaffery told AsianInvestor.

But the appeal of such investment could be set to rise, he argued, especially given the relatively low returns available in other private markets such as core private equity, which is facing much lower returns in the coming years. McCaffery added that commodity investments can provide a hedge against inflation, a growing concern for investors in several major markets.

“You’re starting to see some really interesting opportunities in the [commodity-related] real asset space,” he noted, adding that his team uses specialist managers and co-investments to get exposure, rather than going direct.

“Until 2016/2017 commodities witnessed a selling rather than buying profile,” he noted. Many commodity-linked funds offered flat to negative returns depending on their sector or benchmark.

Commodity-focused hedge funds posted negative returns in four of the seven years since 2011 and only gained 1.77% last year after rising 6.98% in 2016, according to data provider Eurekahedge.

Meanwhile, asset managers seeking private capital opportunities in the commodity space have shifted their focuses. Whereas they typically had a very US-centric approach five years ago, whether in farming, oil-and-gas or even mining plays, today they are looking further afield. “Now there is a much more global opportunity, and manager set, available,” said McCaffery.

The number of private market real asset managers has increased by three to five times since 2012, he noted. Both the fund houses and the assets they invest in are much more globally diverse, presenting a much wider set of strategies.

But many of these managers have struggled to hit their global fundraising targets. This has forced them to offer some very attractive co-investment opportunities, such as oil-and-gas- or agriculture-focused strategies, said McCaffery. “So investors with the right experience have been getting very good entry points on specific deals, allowing them to go in without using blind pools.”

That has led Aberdeen Standard to greatly increase the amount of co-investment it conducts with specialist managers, giving it more transparency around investments, lower fees and potentially greater flexibility in respect of themes or sectors.

Asked to give an example of the kind of deals his firm has made, McCaffery said it recently executed an oil-and-gas co-investment in the Permian Basin, straddling Texas and New Mexico. Aberdeen Standard sold the exposure to an energy company and made three times the amount of capital it had invested within a 15 to 18 month period, he said. 

Closing the output gap

Another plus point for commodity real asset investors is the “rapidly deteriorating output gap”, noted McCaffery (the output gap being the difference between the actual and potential output of an economy).

He pointed out that recent years of under-investment has limited levels of commodity production, which are now being tested as demand continues to grow.

Certainly, the prices of some commodities—notably industrial metals—have staged a rally since early 2016 and particularly in the second half of last year, according to the Bloomberg Commodity Spot Index (see graph below).

Bloomberg Commodity Index (normalised since 1990) 
Click for full view

Others agree that the commodity price upturn will continue.

Mark Lacey, portfolio manager for global energy and precious metals at Schroders, said in a note this week that the recovery in commodity prices is likely to continue in 2018. 

“Underlying supply and demand balances are increasingly positive in key energy, metals and select agricultural markets,” noted London-based Lacey. “Importantly, the structural outlook for the dollar [in which most commodities are priced] looks increasingly weak, while global inflation has likely bottomed.

Given that commodities remain out of fashion in the sentiment cycle, characterised by underweight investor positioning and fund closures, few investors have any proper inflation hedge in their portfolios, added Lacey. 

Moreover, Byron Wien, vice chairman in the private wealth solutions group at Blackstone, revealed his list of top 10 ‘surprises’ for 2018 on January 2. He defines a ‘surprise’ as an event that the average investor would only assign a one in three chance of taking place but which he believes is probable, with a 50%-plus likelihood of happening.

He argued that one such event this year is that the price of West Texas Intermediate crude oil will exceed $80 a barrel; it now stands at around $62, up from $43 in mid-June.

The price will rise, said Wien in a statement, because of continued world growth and unexpected demand from developing markets, together with disappointing hydraulic fracking production, diminished inventories, Opec discipline and only modest production increases from Russia, Nigeria, Venezuela, Iraq and Iran.

Wien also tipped that “inflation becomes an issue of concern”, and suggested that the ongoing growth in the global economy will push up commodity prices.