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Gresham Dynamic Commodity Strategies

Gresham Dynamic Commodity (‘GDC’) is an actively managed long-bias commodity strategy, with an emphasis on capital preservation, that seeks to deliver higher risk-adjusted returns than are available in passive or constrained beta-plus iterations of the Bloomberg Commodity Total Return Index (‘BCOMTR’).

Three Foundational Beliefs of the GDC Investment Philosophy

A foundational belief of the GDC investment philosophy is that the time and sizing of exposure to commodity beta matters greatly and should be dynamically managed. There are two reasons why.

First, commodity futures prices are inherently volatile due to the periods of uncertainty that may surround endogenous variables such as the production, consumption, transportation, and storage of the underlying physical goods. During periods of dislocation, there is often the potential for volatility spillover from one sector to another. For example, during an energy crisis, supply of industrial metals may be constrained as rising energy prices or reduced accessibility to power cause the marginal cost of production to rise.

Therefore, depending on the rate of change of these variables, both independently and in relation to one another, prices can exhibit varying levels of volatility through time. Notably, during commodity bull markets, when supply-demand balances become strained and inventories are drawn down, the level of volatility tends to rise in line with prices as supply buffers are depleted and fears of scarcity rise. During such times, the dynamic management of commodity futures exposure should prove advantageous.

Secondly, commodity beta requires dynamic management because commodity futures prices are also subject to exogenous dynamics. For example, markets as diverse as oil, copper, gold, wheat, and sugar may all be influenced by changes in interest rates, currency values, and geopolitical events. At the extreme, commodity markets can be badly affected by financial panics, when the assumptions that underly asset allocation models are invalidated as all risk assets become highly correlated. Examples of such events include the Global Financial Crisis of 2008-09 and the Pandemic Shock of 2020. Once again, the dynamic management of commodity exposure in relation to endogenous factors influencing the asset class should benefit the investor.

A second foundational belief of the GDC investment philosophy is that capital growth over the lifetime of an investment is congruent with the aspirations of the investor and the manager. Unlike other asset classes, returns from commodity futures originate almost exclusively from capital gains and losses, rather than the more usual combination of capital movements and income so familiar in equities and fixed income.

During bull markets, the primary task of the strategy is to deliver a return in excess of the BCOMTR by positioning the portfolio to take advantage of those markets where the best risk-reward profiles are to be found. If appropriate, GDC will deploy leverage.

The unique nature of commodity returns means that if the aim of capital growth is to be fulfilled, then the manager must be alert to the possibility of large drawdowns or the development of an extended bear market. During downtrends, the primary task is to minimize any market exposure that may result in a significant drawdown in the investor’s capital. In extreme circumstances, where no reasonable risk-reward opportunities can be identified, or the asset class is at high risk of price dislocation, the strategy may avoid market exposure entirely. As a result, GDC retains the flexibility to have up to 100% of the portfolio in cash. The fund may also deploy short positions but will never be net short.

It is critical that investors understand that GDC is not an absolute return strategy, but a long-bias one with an acute focus on the merits of capital preservation during times of stress in commodity markets. Given that an integral component of the GDC is to attempt to preserve capital, tracking error is not included in the investment framework.

A third foundational belief of GDC is that the optimal investment approach cannot be the same under all types of market conditions. This means that portfolio positioning is determined by a repeatable and consistent combination of four types of analysis:

(i) Macroeconomics (‘exogenous’)
(ii) Commodity Fundamentals (‘endogenous’)
(iii) Technicals
(iv) Investor Sentiment

As the importance of various market forces shifts through time, the manager may emphasize one type of analysis, a combination of some analyses, or all types of analysis. For example, while it is possible to construct a profitable long-term framework for commodity markets using macroeconomic analysis, such analysis is not useful during the periods of extreme volatility that may arise because of a sudden supply disruption or a violent hurricane season. Similarly, after extended periods of price trend (either up or down), or during a major geopolitical event (such as the Russian invasion of Ukraine), technical analysis and investor sentiment assume a far greater practical importance than either macroeconomics or commodity fundamentals. It is for this reason that investment philosophy is discretionary rules-based, and the investment process is centered on a belief in the efficacy of holistic market analysis.