Demand for ETFs driven by commodities surge

There is a link in an apparent anomaly in the Exchange Traded Funds’ (ETFs') sector and fund specific out performance this year. While it is it the emerging markets sectors that outperform based on calendar year performance for 2009, it is commodity specific funds that outperform year-to-date.

The top five performing ETF sectors (as of 16 November) were Equity Emerging Europe, producing 75.4 per cent calendar year performance for 2009, Fixed Interest Emerging Markets (73.8 per cent), Equity - Greater China (68.1 per cent) Equity – Latin America (68 per cent) and Equity India (65.5 per cent). While the commodity and energy sector returned just 15.1 per cent, when one looks at the top funds annual performance to date, it is funds from the Commodity and Energy sector that have over performed.

On Trustnet we see the best performing fund as at 16 November was ETF Securities’ Leveraged Lead fund returning 381.1 year-to-date. ETFS dominate the top of the best performing funds table with ETFS Leveraged Copper USD returning (278.6 per cent), ETFS Leveraged Gasoline (208 per cent) and ETFS Leveraged Zinc (154.1 per cent). Market Vectors Russia, part of the Equity Europe Single Country sector, returned 133.4 per cent.

Meera Patel, senior analyst, Hargreaves Lansdown has a theory: "With ETFs, it is emerging markets which are driving the demand for a lot of the commodities. Gold is a typical example, it is used by a lot of the emerging markets, Indian demand for gold is about half of the overall global demand," she says.

Clearly Patel says the state of the different economies is important, with developed economies such as the UK and US still in dire straights in terms of growth and high and rising unemployment. "So I can’t imagine ETF demand is going to be coming from the developed areas. It is going to be the more sexy and spicy type areas that are going to see growth in the next year."

For investors, however, growth returns may be beyond the short-term. "In these areas that have done so well already year to date there is going to be short-term weakness," says Patel.

She adds: "Those investing for just over the next year are going to have to be careful as money has probably already been made in these areas. But if you are thinking medium to long-term there is growth to be captured from these sectors and funds."

Nicholas Brooks, head of research and investment strategy at ETF Securities says while undoubtedly commodities have done very well leveraged funds have done exceptionally well: "By definition they tend to move much more strongly than the overlying commodity. But also commodities have outperformed most other asset classes," he says.

Brooks says there are three factors driving commodities which could keep them in the frame. Firstly cyclical assets and risk assets are performing stronger this year as a rebound from excessively low levels last year when most investors were in panic mode.

"We have seen genuine improvements in underlying macro numbers," he says. "Also government debt and monetary policy has become more of a focus. In such an environment, investors want to hold real assets. Finally, medium to long term fundamentals for most commodities are pretty positive in that there is fairly rapid structural demand coming from the emerging markets, particularly China. And of course by definition supply is finite."

Mick Gilligan, head of research at stockbrokers Killick & Co says he would be cautious about buying into underlying commodities at this point. "China has been stockpiling and if there is no follow through in its stimulus you could see that slowing down. In the absence in any visible improvement in global demand we would be reluctant to go in more aggressively."

Gilligan says the approach to ETFs is less the hunt for big returns but more if sufficiently strong actively managed funds cant be found or if a quick exposure to a sector is needed. "For example we have been buying agricultural equity ETFs, which we think is a good long-term story."