Soft commodities finding their way into retail structures

Known for their high volatility and extreme sensitivity to natural and geopolitical factors, soft commodities are nonetheless being added to the mix of structured products on offer. Sarah Nowakowska reports

A new dawn for soft commodities such as wheat

The number of recent structured products that offer exposure to soft commodities suggests increasing interest from the retail market in investing in the asset class.

The types of products being released include index-tracker certificates offering exposure to a suite of soft commodities, an uncapped five-year growth plan with capital-at-risk which is linked to the performance of an equally weighted basket of four agricultural commodities, and a three-year capital-protected deposit plan linked to the performance of three agricultural commodities.

Soft commodities, which are volatile and easily affected by factors such as liquidity, natural disasters and geopolitical concerns, have risen in price over the past few months, leading some distributors to believe that the price hikes are attracting more retail investors to products offering exposure to soft commodities.

"There is a lot of interest in commodity-based structured products in the retail market," says John Gracey, director of structured products at Merchant Capital in London. "Soft commodities benefit from growing populations and increasing demand for food. Bio-fuels like ethanol are also a driver for higher demand for corn, and on the supply side we're seeing extreme climatic conditions, that could lead to tighter supply."

Increased prosperity in emerging countries and demand for agricultural imports are also factors that make investing in soft commodities more attractive, according to Gracey, whose company is offering two new structured products linked to the performance of a basket of soft commodities to the UK market, which are currently available to retail investors. Merchant Capital's Agricultural Commodities Issue 3 capital-at-risk growth plan is an uncapped five-year product linked to the performance of an equally weighed basket of corn, sugar, cotton and soybeans with 95% capital protection. Its second product on offer is a capital-protected deposit plan linked to the performance of a basket of corn, soybeans and sugar, with an 18.5% interest rate return if the basket's average performance is at or above its initial level at maturity.

Retail investors have definitely grown more interested in soft commodities investment, especially agricultural products

"Soft commodities are a much better story than metals and gold," says Gracey. "Usually people invest in gold when they are nervous and are looking for a safe haven, but if we see the economy recovering in the near future, we're not so confident that gold will continue to provide the fantastic returns we have seen."

A recent survey of commodity investor attitudes carried out by Barclays Capital shows that despite macroeconomic uncertainty and extremely volatile energy markets linked in particular to Japan's nuclear disaster and the recent geopolitical turmoil in the Middle East and North Africa, strong demand and enthusiasm for the asset class as a whole remains. With grains and natural gas markets ranked second and third highest, the world view of the investors surveyed also saw further upward pressure on food and energy prices.

"Retail investors have definitely grown more interested in soft commodities investment, especially agricultural products," says Heiko Geiger, head of public distribution in Germany and Austria at Vontobel in Frankfurt. "Recent events have also had an impact on commodities' rising popularity, especially with Germany wanting to push the off button of its nuclear power stations. Oil and gas are therefore becoming more and more important as a classic source of fossil fuel as well as agricultural commodities in the light of events such as the floods in Australia, New Zealand's earthquake and the revolution in the Ivory Coast that is pushing up the price of cocoa, for instance."

The popularity of soft commodities is also increasing as investors grow more informed and educated about the potential of commodities for portfolio diversification, commodity speculation and using them as an inflation hedge, says Geiger. Vontobel is offering a suite of soft products benchmarked against JP Morgan's Commodity Curve Index, which includes sugar, cotton, cocoa, corn and coffee.

However, while the agricultural market has strengthened and may provide windows of opportunity for investments, soft commodities remain a more exotic investment option, according to Ralph Stemper, director, investor solutions at Barclays Capital in Germany. "Soft commodities are pretty exotic so not many investors really have a feel about whether the price is cheap or not," says Stemper. "People play commodity indexes if they want to cover commodity sectors for a longer term. In the leverage space, you might see from time to time certain soft commodities being traded when something has happened and prices go up. Prices become extremely volatile and very sensitive to what happens in the world, so you see [soft commodities] being a top trade for a specific time period and then disappear again."

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