Large pension funds stick to commodities

Large pension funds say they are sticking to commodity indices to diversify portfolio risks and because they offer better protection against inflation than hedge funds.

Big losses for pension funds in indices such as the S&P Goldman Sachs Commodity Index - down about 15 per cent last year - has fuelled debate about whether investors should be looking at more actively managed portfolios.

"We are looking for a stable portfolio with a desired rate of return ... Our allocation is for the long run," Frans De Wit, a senior investment manager at PGGM, told the Commodities Week conference last week.

His is the second largest Dutch pension fund with 86 billion euros ($121.9 billion) under management.

"If you are looking for high returns then you shouldn't be invested in an index," he said. PGGM has four per cent of its assets in commodities.

Commodities have a negative correlation to stocks and bonds and so are ideal for pension funds, which after the 2000 equity market crash decimated their portfolios have been looking for ways to minimise the risks of large losses.

Many investors have opted for the S&P GSCI because about 70 per cent of its allocation is to energy. That makes it a good hedge against inflation, which erodes corporate earnings.

Inflation typically also means higher interest rates, which often leads to lower prices of government and corporate bonds.

Forays

"(Commodity indices) provide diversification and a negative correlation with most of the assets we hold," said Helene Winch, associate director at UK-based Hermes Pensions Management with £68 billion under management.

Hermes has £1 billion invested in a basket of commodities.

The decision to stay with indices may be vindicated by index performance this year. The S&P GSCI gained more than 18 per cent in the nine months to end-September, while US benchmark the S&P 500 managed about seven per cent.

Investment products based on indices including the S&P GSCI, the Dow Jones AIG, are estimated to manage around $100 billion. Commodity hedge funds are growing, but the amount of money they manage is still a fraction of index money.

Hedge funds often specialise in metals, agricultural commodities or related equities, Some are involved in transport and others are making forays into physical markets.

"It's a different kind of exposure," said Catherine Claydon, a managing director in the pensions advisory group at investment bank Lehman Brothers.

Also a problem is the fact that most commodity hedge funds are small and do not have capacity to manage successfully the large amounts of money pension funds need to allocate.

That, Winch said, raises liquidity issues.

"Trying to find a home for $2 billion ... would be tricky," she said. "If a hedge fund is investing in commodity linked equities, that's what we have (already) and that's what we don't want."

Most indices also have specific allocations to sectors, so if the value of one sector rises then the allocation has to be rebalanced to meet the benchmark criteria.