U.S. pension funds, endowments and foundations are expected to plow as much as $40 billion into commodities this year.
Among the newest investors:
• Ohio Public Employees Retirement System, Columbus, recently made an initial allocation of up to $25 million to a portfolio that will track the Goldman Sachs Commodity index, said Rich Baker, spokesman for the $64.5 billion fund. Fund officials expect to hire counteragents by the third quarter to assist with the commodities swap program that will be managed internally.
• Lumina Foundation for Education, Indianapolis, added commodities as part of a 15% real assets allocation to its $1.19 billion endowment. The fund hired Western Asset Management Co., Pasadena, Calif., to manage an active commodities portfolio using futures and swaps and benchmarked to the Dow Jones-AIG Commodities index.
• Baylor University, Waco, Texas, added a 3.5% exposure to commodities as part of its 15% real assets allocation for its $760 million endowment. The breakdown is 1% of total assets in a commodities index, 1% in a private equity manager that takes equity stakes in mining and metal-producing companies and 1.5% in direct energy managers that buy mature oil and gas assets from major producers.
• CalPERS officials are investigating an initial investment in the asset class to protect against inflation and to add alpha, Mark Anson, chief investment officer, said in a speech at the CFA Institute's annual conference. There is no timetable on when staff at the $182.9 billion California Public Employees' Retirement System, Sacramento, will prepare a proposal for the board.
That institutional investors are beginning to pay attention to the asset class also is supported by data from the major commodity indexes.
Investment by pension funds and other institutional investors in commodities indexes reached $55 billion this month, from $10 billion in 2002, according to estimates by Goldman Sachs & Co.
David Burkart, senior portfolio manager of Barclays Global Investors, San Francisco, expects institutional investors this year to pump at least as much as they did last year into funds that track commodity indexes. In 2004, they invested an estimated $35 billion to $40 billion in such funds, he said. Mr. Burkart noted it's difficult to estimate how much institutions will invest in commodities outside of the indexes.
The GSCI has $35 billion invested in it, while Barclays Capital's Commodity Total Return fund manages about $50 billion, up from $5 billion in 2000. The Barclays fund is a commodity index tracking fund.
One of the reasons for the increased institutional interest is that commodities have just had three fairly good years. The GSCI returned 17% in 2004, 21% in 2003 and 32% in 2002.
Between 1999 and 2004, the average annualized return for commodities was 15%, compared with 8% for bonds, -1% for stocks and 1.5% for private equity.
The most experienced institutional investors in commodities are U.S. endowments and foundations, European pension funds and Canadian pension funds.
The $22.6 billion endowment of Harvard University, Cambridge, Mass., has been investing in commodities for more than 10 years and has 13% allocated to the asset class. According to the university's most recent annual report, the commodities portfolio returned 19.7% in fiscal 2004.
The C$164.7 billion (US$138 billion) Caisse de Depot et Placement du Quebec, Montreal, created a specialized commodities financial instruments portfolio last Aug. 1, which by Dec. 31 accounted for C$1 billion, according to its annual report. The addition was made for higher return potential, greater diversification and a hedge against inflation, said a spokeswoman. The fund already had some exposure to commodities through its C$2.8 billion hedge fund portfolio.
Some of the earliest pension funds to invest in the asset class are increasing their allocations.
For example, Nestle USA Inc., Glendale, Calif., is increasing the $2.1 billion fund's allocation to commodities. Currently, Nestle has $20 million invested in the PIMCO Commodity Real Return Strategy run by Pacific Investment Management Co., Newport Beach, Calif. Also, the €60 billion ($75 billion) Stichting Pensioenfonds PGGM, Zeist, Netherlands, increased its commodities allocation to 5% from 4%.
Commodities was one of the best-performing portfolios of the $27 billion Pennsylvania State Employees' Retirement System, Harrisburg, said Robert R. Gentzel, director of communications. The fund has passive and active exposures to commodities, part of its inflation-protection strategy. The passive allocation is 5% of total fund assets, in which the fund swaps the return on intermediate Treasury inflation-protected securities for the return on the GSCI.
The active allocation, which is 2% of total assets, is in a diversified inflation-protected portfolio that includes commodities futures index contracts.
Officials at The WM Co., London, which tracks 122 Dutch pension funds (excluding giants ABP and PGGM) representing €180 billion, said a recent survey showed that commodity investments produced the best returns — 13% in 2004. But the average allocation to commodities among the funds surveyed by WM was only 1% of total assets.
Still, investing in commodities is complicated. Indeed, returns generated by a token 1% investment might not compensate investors for the costs of entering and monitoring the new asset class, according to a new white paper from Wilshire Consulting, a division of Wilshire Associates Inc., Santa Monica, Calif.
Track records of most managers are short — 10 years or less — forcing index providers to base historical returns on manufactured, rather than actual, returns of large investors in the asset class, consultants said.
Another problem is that there might not be enough capacity or available investment strategies to take in a flood of new institutional-level investments.
"Wilshire has always taken a very conservative approach, and across Wilshire's client list there is very little use" of commodities, said Steven Foresti, managing director, Wilshire Consulting. "But it's hard to argue against returns to be achieved from commodities futures. There's significant limitations from commodities futures.
"While the return history … looks interesting and (commodities) could add diversification benefits, there are practical implementation risks," Mr. Foresti said. "If there are large allocations, there is also a question of capacity of the market to handle that," and whether historic returns will carry forward.
Even with the cautions, the Wilshire white paper said an efficient-frontier model that combines commodities with real estate investment trusts can offer investors high enough returns to compensate for the costs of entry.
Some funds aren't taking the plunge.
Although "commodities are a great diversifier in theory," the Oregon Investment Council is not considering investing in them, said Ron Schmitz, chief investment officer of the Tigard-based council, which oversees the $48 billion Oregon Public Employees Retirement Fund, Salem. The benefits, while similar to those obtained from investing in timber and oil and gas, are not enough for him to push hard to get an allocation, Mr. Schmitz said.
At least one fund reduced its exposure to commodities when falling energy prices hit the sector hard. After suffering losses, the C$84.3 billion Ontario Teachers Pension Plan Board, Toronto temporarily cut its investment in a fund that tracks the GSCI to about 1.5% of total assets, from roughly 3%, but the investment is now back to the original level.
