* Some big-name funds in second year of losses
* Investors pulling money
* Fortress, veteran managers closing funds
* Fall in volatility catches managers out
By Tommy Wilkes and Eric Onstad
LONDON, May 11 (Reuters) - Investors in some of the best-known commodity hedge funds are getting increasingly frustrated by their performance, with some heading for the exit as managers rack up a second year of losses.
Some major funds focused on energy, metals and agricultural products have fallen this year after traders - still cautious about big bets following last year's losses - sought to protect themselves against rising volatility just as it fell.
Clive Capital, the $3.4 billion London-based fund run by Chris Levett, and Armajaro, one of the largest players in the coffee and cocoa markets, are among those in the red.
Meanwhile, Fortress Investment Group's commodities fund, run by William Callanan, this week became the year's third big-name commodity fund to close after it racked up double-digit losses and lost half its assets..
"The multi-billion funds have really been nothing but disappointing over the last couple of years," said one investor, asking not to be named. "For people that only came in when the noise about commodities started a couple of years ago, they (the funds) have basically done nothing."
Commodity managers who forged reputations for eye-catching returns as they rode the long commodity bull run that started some 10 years ago are now struggling with shorter, more uncertain trends.
Aside from Fortress, two of the sector's biggest names also decided to liquidate their funds earlier this year, underlining how tough commodity markets have become for even veteran traders.
Legendary natural gas trader John Arnold is closing down his flagship Centaurus fund after two years of struggling to maintain outsized returns, while oil fund BlueGold - famed for its 200 percent gain in 2008 - is shutting after racking up 35 percent losses last year.
For a sector renowned for managers' ability to navigate volatility, many struggled to get to grips with falls this year.
Some funds came into the year predicting rising volatility in oil prices on the back of escalating tensions around Iran and its nuclear ambitions. Brent crude oil gained about 15 percent early in 2012 but has given up most of its rise.
"The fall in commodity volatility has cost managers over the year. A lot of people bought call options on oil but implied volatility has fallen substantially over the past few months," Jaspal Phull, a portfolio manager at Stenham Asset Management and responsible for investing in commodity funds, said.
"There is definitely a sense that ... managers need to produce returns this year after what was a disappointing 2011."
Metal prices have also hurt funds. Key industrial metal copper, for example, has remained range-bound after gaining around 15 percent early in the year.
"I think people have been trading a lot of options, not only in metals, expecting volatility to increase, but it just hasn't, it's been very flat ... People have lost a lot of money trying to trade volatility, it's not pretty," said a market source, asking not to be named.
Big-name losers include Callanan at Fortress. His fund, which is now returning money to investors, lost 12.6 percent this year to the end of April after falling 8 percent last year.
The $860 million Krom River Commodity Fund has given up 3.6 percent after a 4 percent drop in 2011, while Clive Capital, a big player in oil markets, is down 4.4 percent, compounding last year's 9.9 percent slide, figures seen by Reuters show.
Meanwhile, commodities giant Armajaro, co-founded by cocoa trader Anthony Ward, saw its flagship fund fall 1.6 percent in the first quarter and its computer-driven fund shed 10 percent, according to figures seen by Reuters.
The average commodity fund has fared only slightly better. Funds focused on energy or basic materials are up 2.15 percent to early May, but this is less than half the 4.42 percent rise of the average fund, according to Hedge Fund Research.
Not all funds are in their second year of losses, however. Mike Coleman's Merchant Commodity Fund has rebounded after a slide in 2011. The portfolio has gained 11 percent up to the end of April after falling 30.1 percent last year.
Poor performance is encouraging some investors to sell.
Many who poured into commodity funds after the financial crisis, wanting to diversify away from stock and bond markets ravaged by volatility, will have missed out on the boom years - epitomised by BlueGold's 200 percent gain in 2008.
Assets in Callanan's fund slid 46 percent to $473 million during the first quarter, a company filing showed. The fund, which ceases trading around May 23, ran $1.2 billion last June.
One investor in Clive and Armajaro, asking not to be named, said it was considering cutting its holdings as it now preferred to invest in smaller, nimbler managers.
Clive and Armajaro declined to comment.
"Everyone's had quite a lot of investors pulling money out and that causes a lot of rebalancing issues. They're pulling out for a number of reasons, not just outright performance, maybe a different strategy is being employed," the market source said.
The worry now is that commodity markets are set to suffer renewed volatility, driven by geopolitical concerns in energy markets and weaker growth in China, the world's biggest consumer of raw materials, making it even tougher for managers to trade.
Gabriel Garcin, portfolio manager at Paris-based Europanel Research & Alternative Asset Management, has shied away from investing in pure commodity hedge funds partly due to the relatively small markets in which they invest.
"The Chinese slowdown is also adding to the asymmetry of returns in commodities. You have these two parameters that could create a lot of volatility and a very tough environment for traders," he said.