Double the growth from oil and metals

Q I am convinced that if I commit to a five- to six-year period, I will make money from investing in oil and metals, such as copper, zinc and aluminium. I do not want to trade in these commodities by speculating on daily or weekly movements but would rather find a fund that invests in a combination of commodities. I am willing to take a small risk on my capital in return for maximum growth. What participation rates can I expect from such a fund?

A This will depend on the bank or investment company you go to as there can be a huge differential between product providers. I am aware of funds that give investors growth rates of between 70% and 190% - a considerable difference.

The participation rate will also depend on the currency of the fund, time horizon and averaging of the performance of each commodity, as well as, of course, the commodities in the fund themselves.

Historic evidence suggests that market cycles in commodities are very long, lasting many decades. A leading authority in commodities investment, Jim Rogers, author of Hot Commodities, states that the shortest commodity bull market identified in his research lasted 15 years, and the longest for 23 years.

In his view, the current bull run started in 1999 and this market therefore has many years of positive performance ahead. The price of commodities is largely determined by demand and supply.

The fundamentals now point to a long period of sustained and rising demand, which is set against tight supply. A study by Ibbotson Associates concluded also that a conservatively managed portfolio should have a weighting of between 9-13% in commodities investment.

As regards which commodities to invest in, I would opt for a broad basket of oil, gas and metals. There are specific funds set up that consist of, say, eight commodities with an equal weighting into each. Your return at the end of the five or six years is equal to the closing level (usually involving averaging over the last three months) less the opening value, multiplied by a factor.

The best product I have researched offers 1.9 times the growth of the commodity basket. If, therefore, at the end of the term, the basket of commodities has increased by 50%, you would receive 1.9 x 50%, i.e. 95% growth! A Lm10,000 investment therefore turns into Lm19,500. So where is the catch?

To receive such attractive returns, a proportion of your capital would be at risk. In the above case, 90% of your capital would however still be protected at maturity date. The chances of losing 10% of your capital would however be odds of millions:1 as your capital would be reduced by 1% for every 10% fall in the portfolio.

This means that in order to experience the maximum 10% capital loss, the commodity portfolio price would have to fall to zero, i.e. oil, gas, copper, etc., would all be free!

As you can see, there are some wonderful commodity products on the market where your downside risk is extremely low but the upside potential gain is extremely high.

(Source: Dawnay Day Quantum)

Past performance is no guide to the future and, except where amounts are guaranteed, the price of your investments (and the currency in which it is denominated) may fall as well as rise. Your personal tax situation will depend on residence. Always consult a professional adviser. This article does not intend to give investment advice and its contents should not be construed as such. Readers are encouraged to seek professional advice on their personal financial situation.

Mark Hollingsworth is the director of Hollingsworth International Financial Services - licensed by the MFSA to provide investment services under the Investment Services Act 1994 (IS/32457). Address any financial questions to: Mark Hollingsworth, c/o The Sunday Times, PO Box 328, Valletta CMR 01. Alternatively, he can be contacted on 2131-6298/9984-2614 or e-mail mh@hollingsworth-int.com.

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