The Big Dogs of Physical Commodity Trading

Those of us in managed futures live in a world full of contracts, rules, regulations, and hardly a physical commodity in sight during trades. But there’s an underbelly to all of that activity called physical commodity trading that sometimes gets overlooked by those of us who merely trade the derivatives of all that oil, grains, and what not.

And the physical side of the commodities business is HUGE! We’re talking trillions of dollars huge, and likely among the biggest futures market participants as well. But these names are hardly the household names of other billion dollar businesses like UPS or IBM or the like. These firms largely remain out of the spotlight while they are shipping oil around the world and strip mining the rain forests.

Just who are they? Futures Magazine’s recent piece highlighted the Top 10 physical commodity traders (with an added angle of looking at the trouble they’ve gotten in before). The combined 2012 annual revenue of their Top 10 comes out to be $1.3 Trillion (yes that’s trillion with a capital T), with $60 Billion coming from the tenth ranked physical trader to a whopping $303 Billion stemming from the king of physical commodity trading.

Topping the list is Vitol Group, representing more than a third of the Top Ten’s revenue. They’re the world’s largest physical gas and oil trader. Last year, they sold 2.4 million barrels of Crude Oil. But that’s not all. They also trade sugar, metals, and grains, in large quantities. Just this month, Vitol delivered 144,000 metric tons of Raw Sugar.  Coming in at number two is Glencore International, with revenue of $236 Billion in 2012. The commodity trading giant went public back in May of 2011, with the company’s worth valued at $60 Billion dollars (which is more than Boeing and Ford Motors.) Foreign Policy called them “A Giant among Giants,” after they released private information leading up to their IPO:

The company controlled more than half the international tradable market in zinc and copper and about a third of the world’s seaborne coal; was one of the world’s largest grain exporters, with about 9 percent of the global market; and handled 3 percent of daily global oil consumption for customers ranging from state-owned energy companies in Brazil and India to American multinationals like ExxonMobil and Chevron.

Did they just say half of international tradable zinc and copper?

We are always amazed at the size of the giants of the managed futures industry, like Winton with $25 Billion in assets under management and what we would guess to be annual revenues of $500 to $700 million in a good performance year. But the physical trading firms make even the largest of large CTA’s look like small play things in comparison.

Let’s all hope they stay focused on making billions in their own world instead of coming into the managed futures world to compete… Although with 9 out of the 10 having had some sort of run in with the law, with most paying tens of millions in fines, maybe they would just as soon stay away from being more heavily regulated.

What Everybody Ought to Know About Managed Futures Asset Class Growth

We covered back in November of 2012 how the reported total assets under management in the managed futures industry is a very deceiving number, based on it including the largest hedge fund in the world – $125 Billion + Bridgewater Associates. We found back then that the non-managed futures program Bridgewater represented a full 56% of the assets under management, with the largest actual managed futures program Winton representing another 8%, for a total of 64% of the reported investment in the asset class belonging to just two managers (one of which isn’t a managed futures investment).

Well – when talking about this little discrepancy in a recent conversation, the question was asked:

What does the growth look like without these two behemoths? Is the managed futures asset class even growing without considering Bridgewater and Winton? Great question!

The industry sure likes to tout the tremendous growth of assets under management (see CME here,Open Markets here); but is that growth really across the asset class, or centered on these two marvels of money raising.

It sounded like just the sort of thing we like to dig our hands into… and so we crunched the numbers in the BarclayHedge database to see what the real Ex. Winton/Bridgewater growth has looked like since the end of 2008. What did we find….

• 87% ($102b) of the $125 Billion in new money to managed futures since Dec. ’08 has come from Winton/Bridgewater.
• Just $16 Billion in new money has come into non Winton/Bridgewater managers since Dec. ’08.
• The asset class grew 60% since ’08
• The Ex- Winton/Bridgewater asset class grew just 15% since ’08
• The asset class is down -$3 Billion since June 2012
• The Ex- Winton/Bridgewater asset class is down -$24 Billion since June 2012

Managed Futures Assets Under Management Growth, both with and without Winton & Bridgewater.

(Disclaimer: Past performance is not necessarily indicative to future results)
Source: BarclayHedge Database

Here’s what the quarterly inflows/outflows look like if we remove Winton & Bridghewater, with a current 4 quarter average of a little more than -$5 Billion flowing out of the industry quarterly.

(Disclaimer: Past performance is not necessarily indicative to future results)
Source: BarclayHedge Database

Now, we’re not trying to cause (too much) trouble, but it occurs to us that those building out business plans, getting jobs in the industry, and trying to raise money would be a lot better served to see the real ex-Winton/Bridgewater numbers. We’ve met with more than a few managers who feel they are falling behind in their asset raising, but the reality is they may be doing quite well in light of $5 Billion a quarter currently moving out of managed futures.

As for that quarterly average dipping into negative territory – the contrarian in us loves to see it. We know we’ve been banging the “managed futures is due for a turn drum” for quite some time, but that has all been based on the cyclical nature of trends and those who follow them. The only thing stronger than those cycles, it seems, is investor’s penchant for getting in at the top and out at the bottom… To us, that means good things are coming for managed futures.

What percentage of the futures industry is represented by CTA’s?

We received this question from one of our readers the other day, and it’s a deceivingly simple little question that’s a lot more difficult to answer than you might think.

For starters, do you mean how much AUM does managed futures hold? We peg it at about $205 Billion AUM after removing Bridgewater from Barclayhedge’s numbers. That is a good measure of the assets controlled by CTAs (managed futures managers), but does little to compare to the futures industry as a whole; because managed futures considers the nominal amount of assets (an investor having $500k cash traded as $1 million would be counted as $1 million – the nominal amount), while the rest of the industry is cash based – with measures considering how much in customer assets are held by the FCM’s (futures clearing merchants).

So, while it’s an apples to oranges comparison, we can check out how much customer assets are held across the futures industry by pulling up the CFTC’s financial data for FCMs, and sum the customer required sections to come up with the total customer assets held at FCMs of about $180 Billion. Now, how many such customer assets held by FCMs are in managed futures? Well, if we break down the $205 billion in managed futures by assuming the average cash to nominal level is 3 to 1, we can assume there is $68 Billion in managed futures ‘cash’ held in these FCMs ($205B/3), giving us a managed futures share of futures industry of 37%, if the average leverage used is 2 to 1, it’s a 56% share. If 5 to 1, a 23% share.  The trick is knowing what the average notional funding level is amongst managed futures, but we think it is at least 5 to 1 these days.

Disclaimer: (Past performance is not necessarily indicative of future results)

What about trading volume?

If you aren’t crazy about some of the assumptions made there, what if we look at the amount of trading done versus the amount of assets held? That’s a fun little exercise too:

Again, we start by adjusting the $331.6 Billion in assets reported by BarclayHedge as of the end of thesecond quarter of 2013 (Sol, can’t you just remove Bridgewater so we don’t have to do that math every time we talk about managed futures AUM?), by removing Bridgewater’s $127 Billion in AUM, leaving $205 Billion in assets under management for managed futures.

We’re halfway there, and now need to turn that money under management into the total number of contracts traded annually by CTA’s. Converting AUM to contracts is found with a statistic reported by managed futures advisors called Round Turns per Million. What’s that you ask? A ‘round turn’ is a single completed trade (both a buy and a sell), as opposed to a side which is half of the full trade – either the buy or the sell. Round turns per Million measures how many ‘round turns’ are done per 1 million invested in a managed futures program. Multiply that number by 2 (there’s 2 sides per 1 round turn) and you get the number of contracts traded per million.

Per our experiences in the space, we can tell you the average CTA’s R/Ts per mm is about 1,500. So how many million dollar units are there in the $205 Billion under management? There’s 205,000 units of 1 million, meaning we can multiply that by 1,500 to arrive at 307 Million R/T’s overall per year for the managed futures industry. Convert that to contracts by multiplying by 2 and we get 616 Million contacts.

According to the Futures Industry, there are around 12 billion futures traded annually, and about 12 billion in options, combining to an end number of 24 billion”derivatives” traded globally each year.  So if you divide 616 Million contracts from managed futures by $24 Billion, we get around 2.6% of derivatives. If just on futures, we get 5.2%

If you’re like us and that sounds a little light… let’s dig deeper. From a global scale, it turns out that around 3 billion of the global volume is from Korea (which very few managed futures program access), 2 Billion from the NYSE and Indian stock exchanges, and about 1 billion each from Brazil, Russia, and India’s commodity exchange.  Remove all those totals and we’re left with about 7 Billion contracts regularly traded by managed futures managers. When considering what percent of that 7 Billion, the managed futures volume creeps up towards 9% of futures volume on the leading futures exchanges.

Disclaimer: (Past performance is not necessarily indicative of future results)