Four Elements Capital

A less directional approach to commodities

Originally published in the December 2008/January 2009 issue

Four Elements Capital is one of the latest hedge fund ventures to be launched using an existing team from within a bank. In this case it is a commodities team, with considerable experience of working together, that left BNP Paribas and JP Morgan to make use of the opportunities and flexibility that exist within a hedge fund structure.

Four Elements is being led by Lionel Semonin, a former managing director with BNP’s global commodity investor group. He and his team have left London to move to Singapore and are raising money for their first fund, the Earth Element Fund. “There has been a lot of discussion over the last two years about the commodities markets,” says Semonin. “From the investor’s perspective, commodities look very volatile, but they can also be an interesting investment. The real question is how they are being managed.”

Semonin recognises that investors can already obtain efficient commodities exposure via ETFs, but he argues his firm will be able to extract value via a diversified approach that will look at systematic and fundamental analysis across 30 commodities. “Our approach is to provide diversification over the entire asset class, and thereby provide diversification of return,” he explains.

This partly explains his decision to locate the Four Elements team, which includes Bertrand Egsbaek, Leila Kuhlenthal, Marion Lefevre and Lei Shen, to Singapore. It’s not just the better weather. Singapore has an active commodities market, is regularly visited by active hedge fund investors in the region and also has the advantage of being close to major zones of commodities consumption, like China and India. Both countries were cited as major drivers of global commodities prices in 2007-08 and that’s not likely to change over the medium term. Each member of the team focuses on different markets and the fund itself takes what Semonin calls “a true commodity view,” i.e. there is no unique point signal per commodity. Each commodity is approached from both a fundamental and a quantitative perspective and the models in use are extensively stress-tested.

“More recently the focus has been on consumption,” says Semonin. “The inelasticity of commodities production means that the volatility right now is coming from the consumption side. Producers cannot change their capacity overnight.” Cocoa trees and deep wells are not easy to switch on and off to cope with wide variances in global demand. And once capacity is cut back, there will be less to meet future immediate appetite, particularly when the predicted global infrastructure boom of 2009 gathers pace.

Four Elements is not an intra-day trader, and has no plans to be sitting in the trading pits in Chicago: the Chicago Mercantile Exchange’s IT hub allows the firm access to the CME which provides it with the same low latency access a CTA on South Wacker Drive might enjoy. But beyond this, being based in Singapore gives it the ability to react to overnight movements ahead of the opening of the US markets.

A research-based approach
In its previous incarnation the London-based team was responsible for developing proprietary, alpha-generating, algorithmic commodity strategies designed to exploit profitable opportunities within commodity markets. It developed indices which were considered to be cutting edge commodities exposure instruments, including a first stage long/short momentum index and a second stage long/short multi-factor index.

Semonin says the current volatile environment will suit his firm’s approach well: “We’re seeing predictable volatility now,” he says. “When there’s an increase in predictable volatility, there is the potential there to generate alpha.”

Four Elements stresses a research-based approach that has been developed over time thanks to the team’s substantial commodities experience and which avoids concentration risk within any specific commodity market. It also maintains exposure limits to those classes which the team feel are highly correlated (e.g. gas and oil; base metals). The firm’s founder accepts that commodities have taken a beating in the second half of this year, but sees it as more of a correction than anything more fundamental. “There is still a rationale for saying that commodities prices will increase overall,” he says. “This year was a pretty bad situation: a lot of commodity beta plays lost a lot of money, but compared with equity plays it has not been as bad.”

From the beginning of 2005 until now, a long only diversified commodities investment would have generated a decent return. Over the three year, or five to ten year time horizons, commodities can still shine and investors can potentially tap into such growth via an ETF, but the question remains whether they want to wear the losses as well. An actively managed long/short approach can help minimise these. Four Elements’ own virtual portfolio has been almost entirely short for the last four months because the managers are relying on their positioning to ensure zero or negative correlation.

Commodities futures funds are gathering increasing traction with investors at the moment and it’s not just about the performance figures they’ve been able to generate either. They also offer a high degree of liquidity, which investors find reassuring.

“We’ve been surprised at how much interest this is generating,” says Semonin. He thinks investors will now be moving away from an aggressive, directional approach to commodities investing, seeking ways to add funds like his to a more balanced approach. “They’re looking actively to implement strategies that will negate the potential losses they’re taking on the credit and equities books.”

The Earth Element Fund soft launched in December and has a capacity of US$500 million.


Lionel Semonin is Founder and CIO, Four Elements Capital
and has been working in the investment industry for more than 13 years in both Asia and Europe. Most recently he was responsible for building the commodity investor business at JPMorgan and BNP Paribas. He worked for more than 10 years at JPMorgan, as Head of its Relative Value Team in Singapore, as well as Regional Head of Structuring and Marketing for Equity, commodity and hybrid derivatives in Hong Kong, and as Head of the Global Commodity Investor Group in London