Commodities house of the year

Barclays Capital

Martin Woodhams, Barclays Capital

Barclays Capital's ability to marry clients' ideas with more bespoke solutions suited to their particular needs, while ensuring strong secondary liquidity for its products, has made it the commodities house of choice this year. While one of the major themes of the period has been to access precious metals, especially gold, a more volatile commodity market prompted the bank to focus on extracting alpha rather than relying on the more uncertain fundamentals of the market to meet a more undecided and skittish investor appetite.

"Some commodities have risen amazingly, while others have risen for a short time and then fallen," says Martin Woodhams, managing director, head of commodity structuring at BarCap. "We wanted to bring products very much towards the alpha end. One undeniable theme has been that people wanted safe-haven status in gold, not just as a safe-haven asset but also to be able to own it - something that isn't a piece of paper - and we've been keen to encourage that and are building a vault to get added storage space."

Although bullish on precious metals, the bank remained selective in terms of underlying, avoiding those that it deemed too speculative or likely to encounter high volatility, such as silver.

Increased investor interest in accessing commodities through more sophisticated strategies, combined with the poor performance of traditional benchmark indexes in recent years, led the bank to develop its Backwardation Index, a portfolio allocation strategy that aims to provide a diversified commodity investment targeting commodities with the highest upside potential.

"The main driver for the Backwardation Index was to develop an investable commodity index that was fundamentally based, intuitive to understand and provided better commodity beta return characteristics," says Woodhams. "It leverages the well-researched characteristics of commodity markets that backwardated commodities tend to outperform."

Launched last November, the Backwardation Index comprises 10 commodities selected based on their inventory levels, which are measures by the level of backwardation or contango. The index raised more than $400 million to date in assets under management, and has outperformed the Dow Jones-UBSCI by 5.69% in the year to date.

Hans Peter Zbinden, Geneva-based executive director, head of structured products, treasury and trading at Union Bancaire Privée, who used the index for his clients, says: "They have a very open and proactive approach as well as competitive prices. Commodities as a whole are suffering due to the current market environment, but Barclays Capital's Backwardation Index, which we used for our clients, outperforms."

Aiming to offer a unique solution for a European public-sector client that linked both the need to hedge energy price risk with increased return on its cash holdings, the bank created an issuance programme that takes advantage of the German interbank deposit protection scheme, effectively selling its first commodity-linked structured product covered by the German protection scheme in July. Linked to oil, the structured deposit has a capital-protected, five-year tenor and offers participation in the uncapped positive performance of Brent crude oil.

"Some clients were worried about sovereign and bank credit risk. Here, the deposit we issue is not just protected by a Barclays guarantee, there is this whole guarantee scheme that backs it up, providing two layers of protection," says Bharath Manium, managing director, commodity investor solutions at BarCap. "This was very important to the client, because it was a public-sector entity in Germany and they had a heightened sense of fiduciary duty for the money [invested]. This note not only gave them investment returns if oil prices went up, but would also protect them in case of high oil prices eating into their budget."

Tackling the low-yield environment was at the heart of identifying an arbitrage opportunity in the carbon emissions market caused by a steepening of the forward curve. "The carbon emissions market is unique because it's the only commodity market where the underlying actually sits in a clearing system," says Manium. "Most others sit in a warehouse, tank or vault, but here it's a synthetic type of underlying. The idea was to exploit the contango by buying one part of the curve while locking in the sale at the forward point and holding the instrument that you buy until you have to deliver it into your short position."

Aimed at institutional investors, such as money-market funds, the EU allowances linked yield enhancement note is a buy-to-hold investment of which the average tenor would be around 15 months. "This is a very good example of taking alpha out of the market, not about taking a directional bet that the emissions market is going up or down," says Woodhams. "This is one of those vagaries of the commodities market that allows you to take yield out of the market. We had more customers than we could source that particular alpha from due to the dynamics of that particular market."