Hedge Fund Snaps Seven Annual Gains in ‘Ugly Year’: Commodities

Aisling Analitycs Pte Ltd. Managing Director Coleman
Michael Coleman, managing director at Aisling Analytics Pte Ltd. Photographer: Dale de la Rey/Bloomberg

Michael Coleman is suspending a three-decade trading career to focus on risk after a year in which the Merchant Commodity Fund he co-founded lost 30 percent and its assets contracted twice as much.

Assets fell to about $550 million last month, from $1.56 billion at the end of 2010, said Singapore-based Coleman, who gave up trading to become chief risk officer. The biggest losing bet was in sugar before a 10-month decline ended with winning wagers in oil, fuels, sugar and soybeans, he said. The assets of the hedge fund, started in June 2004 with $10 million, are now traded mostly by co-founder Doug King.

Merchant’s 2011 slump, which still left its initial investors with a return of 236 percent, illustrates last year’s swings in raw materials. While the Standard & Poor’s GSCI Index of 24 commodities gained 2.1 percent for all of last year, it rose as much as 21 percent, before falling 25 percent and then rallying 13 percent. The average fund tracked by the Newedge Commodity Trading Index lost 4.2 percent last year, beating Merchant for only the second time in seven years.

“The problem was that we were wrong,” said Coleman, the 51-year-old son of a plumber from Lancashire in northwest England who graduated from Oxford University in 1982. “The cause of our loss came from a few changes in supply and demand, nothing dramatic. Normally we have seven wins to three losses. Last year, we were down to four wins to six losses.”

Palm-Oil Yields

The fund, whose worst performance before 2011 was a 5 percent gain in its first seven months of trading, was wrong twice on sugar last year, Coleman said. They were bullish at end-2010 before prices dropped in February and March and they became bearish before the commodity rallied in June and July, he said. A wager on rising vegetable-oil prices also soured as yields in Malaysia, the second-biggest producer of palm oil after Indonesia, unexpectedly strengthened.

Traders for oil, coal and freight have been added and the fund is increasing its “core investments there,” said London-based King. Still, “we remain totally opportunity-driven and if the opportunity is in agriculture we will still weight our investments in that sector,” he said. The agricultural markets are “un-crowded and friendless” after three to four years of leaving investors “constantly disappointed,” he said. Merchant is bullish on soybeans and vegetable oils.

Monthly losses peaked at more than 10 percent in June and no gains were made until November, according to a fund document. Leverage, the notional value of all long and short positions divided by assets, fell as low as 0.4 by September, from 3.6 in April. The ratio rose as high as 8.6 in 2005. Merchant lost a further 4.2 percent last month.

Price Swings

“It was an ugly, ugly year,” said 45-year-old King, who relocated to London and got married in October after 14 years in Switzerland. “Our volatility has been heightened over the past three or four years and our goal is to cut that volatility.”

The price swings also hurt other traders. Cargill Inc., the largest closely held U.S. company, posted an 88 percent drop in profit in the three months through November and said sugar was one of the causes. Noble Group Ltd., a Hong Kong-based commodity supplier part-owned by China’s sovereign wealth fund, reported its first quarterly loss in about 14 years in November.

Both Coleman and King were employees of Minneapolis-based Cargill, the former as the global head of rubber trading who joined the company after graduation, and the latter as the leader of the petroleum-trading team.

Commodity Assets

“I’m very confident the managers will be able to turn it around,” said Stephane Pizzo, a fund manager and founder of Singapore-based Lotus Peak Capital Pte, who has put money into Merchant since 2006. “The fund performance was still within what one could expect based on Merchant’s 20 percent annual volatility target.”

Gains peaked at 47 percent in 2006, with 37 percent advances in 2005 and 2007. Assets under management reached a record $2.54 billion in February 2008.

Global commodity investments climbed $19 billion to $399 billion last year, according to Barclays Capital, which measures money in exchange-traded products, index swaps and medium-term notes. Inflows fell to $15 billion from $67 billion in 2010, the weakest since 2002, the bank estimates.

“Markets are a game; it’s a human construct with human rules,” said Coleman, a former rugby player and a director of St. Helens Rugby Football Club in Lancashire. Commodity traders are often sports players because “you can handle stress, you have experience in adversity because if you play sports, you have had both defeat and victory.”

Closing Office

After the management changes, Coleman oversees the size of trades and asset allocation, describing his role as “defense” and King as “offence.” He gave up trading his own portfolio as of Jan. 1 and King remains chief investment officer.

King will continue to trade most of the assets, with the balance handled by other employees. They include Chan Bhima, formerly of JPMorgan Chase & Co., who trades coal and freight. King’s move means the fund is closing its Zug office and transferring three people to London, he said.

Merchant still sees opportunities in agriculture. Drought in South America is damaging oilseed production and reducing stockpiles, King said. Soybeans may trade as high as $15 a bushel this year, from $12.32 now, and soybean oil may climb to 60 cents a pound from 52.81 cents, he said.

Brent, the benchmark for more than half of the world’s crude, may trade from $100 to $120 a barrel, King said. The commodity traded at $118.29 today. Energy accounted for 53 percent of the fund’s investments last year.

Merchant is more likely to focus on relative-value trades this year than outright bets on the price of a single commodity, Coleman said. Gasoline could move to a “reasonable premium to heating oil in the summer” from a discount now, said King.

“If you have been in a business for a long time, you have a mechanism of living through what is unpleasant,” Coleman said. “If you get beat 5-0 last week, you’re not so keen to play next week. That’s why it’s important to stop compounding negative as soon as possible.”

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