London (HedgeNordic) – CTA is an acronym for commodity trading adviser, because the first futures markets were in commodities. Yet some CTAs nowadays can be dominated by equities, bonds, interest rates and other financial contracts while others still allow potential for commodities to make up as much as half of their risk.

Commodity exposure

Aspect Capital’s risk allocation to commodities in both its flagship CTA and its newer alternative markets product has averaged 35% but has over time contributed anywhere between 10% to just over 50% of the overall portfolio risk. This highlights the adaptive nature of diversified trend following strategies. The two traditional and alternative markets universes have seen peak and trough commodity exposure at different times, reflecting the wide range of markets in scope. A snapshot in July 2024 showed the more traditional CTA portfolio around 45-50% of commodity risk contribution and the esoteric market portfolio with around 23% in commodities – though back in 2022 this portfolio had about 50% of its risk in commodities. “The trend programs we run are adaptive and reactive as a function of the opportunity set. Their drivers are always very varied, and this is particularly evident across the universe of commodities that CTAs like us can access,” says Razvan Remsing, Director of Investment Solutions.

“The trend programs we run are adaptive and reactive as a function of the opportunity set. Their drivers are always very varied, and this is particularly evident across the universe of commodities that CTAs like us can access.”

Prior peaks of commodity exposure included May-June 2008 when oil briefly spiked up to nearly USD150 a barrel, as well as the oil price collapse in 2014, the second half of 2015 and early 2022 just after the Russian invasion of Ukraine, when sanctions and counter-sanctions threatened gas supplies. “There were other factors at work in 2022 contributing to the general shortage of gas inventories in Europe, ahead of the shock withdrawal of the Russian supply: the very hot summer in 2021 resulted in low alternative power generation from hydro and wind at the same time as France throttling down its nuclear output – leading to depleted gas inventories,” recalls Remsing. Overall, 2022 saw some of the broadest commodity trend action as inflation accelerated, as well as big exposure to the bear market in bonds. Remsing acknowledges that equities and bonds are generally more liquid than commodities, but the firm’s level of assets allow for ample commodity exposure when trends emerge.

Performance contribution

In 2014-2015, roughly two thirds of Aspect’s net returns came from commodities. An interesting observation the firm made this year came in their piece titled Cocoa Loco. Cocoa has garnered a lot of attention in 2024 due to a significant price rally. In the piece, Aspect found that when using a simplistic trend signal eight of the top ten trades of all time were commodities. Markets in that top ten included German Phelix Baseload electricity; Dutch Natural Gas; European Emissions; Gold; Platinum; Silver and Cocoa.

Cocoa is one of the more dramatic and recent illustrations of the importance of maintaining diversified exposure to a broad universe of commodities and not giving up on some markets even if they have extended periods without meaningful trends. Capturing unpredictable price trends like this is a key attribute for firms like Aspect. “Cocoa was very boring and uninteresting for over a decade before its surge in 2023 and 2024. Depressed prices and ineffective government subsidies prevented the local farmers from being able to invest in upgrading their plantations resulting in some rather tired and less resilient cocoa trees in west Africa. El Niño in 2023 brought about excessive rainfall in the region, which affected the already fragile cocoa trees, resulting in vastly reduced crop yield expectations. Not only was the outlook for crop yield severely reduced but towards the end of the year, Black pod disease was then the perfect storm that decimated the existing crop and made the price go exponential. Our trend models ably captured that price rally in 2023 and then systematically trimmed the positions during 2024 when the cocoa market became parabolic and very volatile. Not only did we provide liquidity into the increasingly stressed market as we sold down our positions, but risk was always under control which is a key tenet of our investment approach,” says Remsing. Carbon emissions were another market that was unremarkable for many years before its price tripled in late 2021 and also had a significant pullback in late 2023 and early 2024.

“Cocoa was very boring and uninteresting for over a decade before its surge in 2023 and 2024.”

Brent Crude oil, West Texas Intermediate oil, Gasoline, Henry Hub natural gas, Dutch natural gas and UK natural gas have all exhibited significant trends since 2021. Performance from commodities can be very diversifying to financial assets and has the potential to fill gaps when no trends are seen in stocks or bonds. 2014-15 was a key example of this. Having a diversified exposure to both major asset classes as well as having the ability to significantly reduce participation when trends are not present helps to amplify performance in those markets that do display trends.  Aspect believes scaling down risk to trendless markets rather than forcing a fixed allocation regardless of opportunity set highlights the adaptive and agile characteristics investors can benefit from through CTAs.

Growing commodity universe

Aspect has traded a multitude of commodities, including cocoa, from the firm’s inception in 1997 and this has now grown to about 140 commodity markets across their products to provide additional diversification. For instance, the same grain can perform differently depending on where it is grown and traded. The alternative markets portfolio now trades as many as 120 commodities including Chinese listed futures. All of Aspect’s trend solutions can potentially gain exposure to the growing number of internationalized Chinese futures, while the dedicated China portfolio can also access local futures markets using the firm’s QFI license or via swaps and has been traded onshore since 2016.

Tailoring models to commodities

Financial markets and commodity markets behave differently. “Financial markets can be more prone to policymaker interference and control whereas commodities, absent a cartel, are generally a rather heterogenous, idiosyncratic collection of markets making them harder to control as a collective,” explains Remsing. Though the OPEC-Plus cartel has some power to influence  oil prices, and there have also been cartels in diamonds, most commodity markets are free to express their own trends in a clean way.

“Financial markets can be more prone to policymaker interference and control whereas commodities, absent a cartel, are generally a rather heterogenous, idiosyncratic collection of markets making them harder to control as a collective.”

Therefore, Aspect has developed some models specific to commodities. “Curve dynamics and term structure effects are some of the many effects used in conjunction with our trend models, but can be hard to disentangle from seasonality,” points out Remsing. The models also vary between types of commodities. Not all commodities exhibit seasonal patterns, and data can be patchy across the longer dated contracts preventing term structure models from being practical.  Chinese commodity futures, nearly 60 of them, by virtue of their locality, mean both the producer and consumer side have different drivers than their western counterpart commodity markets. A necessary level of customisation is inevitable.

Broad exposure

Aspect lets its models identify the winners and does not second guess which markets are more likely to trend. “We benefit from breadth of coverage without needing to employ 140 commodity specialists because directional trend models can capture moves as commodities ebb and flow at different times. When signals are weak we may have only small positions but we stay exposed because we do not know when and where the next big moves will come from. We need to be reactive and dynamic in response to exogenous shocks that can produce large moves and prolonged ripple effects,” says Remsing.

“We benefit from breadth of coverage without needing to employ 140 commodity specialists because directional trend models can capture moves as commodities ebb and flow at different times. When signals are weak we may have only small positions but we stay exposed because we do not know when and where the next big moves will come from.”

Commodity prices are driven by a kaleidoscope of factors, including climate change, technology evolution, data centres which require metals intensive hardware and have an associated energy cost, food security concerns, local government actions and geopolitics: the Ukraine war disrupted both grain and fertilizer markets, while more recently shipping and freight were affected by Red Sea hostilities leading to routes being diverted around the cape of Africa. It is hard to predict exactly which commodities will be the biggest winners and losers before these shocks and surprises materialize.

While Aspect are generalists and trade broad portfolios across all asset classes, the firm wants significant exposure to commodities, including as many markets as possible to maximise their chances of catching the next big and diversifying moves.

Note: Any opinions expressed are subject to change and should not be interpreted as investment advice or a recommendation. Any person making an investment in an Aspect Product must be able to bear the risks involved and should pay particular attention to the risk factors and conflicts of interests sections of each Aspect Product’s offering documents. No assurance can be given that any Aspect Product’s investment objective will be achieved.