CalPERS to go resource mining

SACRAMENTO, Calif. — CalPERS officials are contemplating a major shift into natural resources that would span all major asset classes — public and private equities, bonds and real estate.

While most institutional investors are tiptoeing into the "super-category" through an allocation to indexed commodities futures, officials at the $215.2 billion California Public Employees' Retirement System, Sacramento, think the opportunities lie in active approaches that make bets both on natural resources and the services that support those industries, including infrastructure investing.

Natural resources companies have underinvested in finding new reserves, improving technology and developing energy infrastructure for decades because of low energy prices. With crude oil prices now in the range of $60 to $70 per barrel, the demand for investment capital has increased dramatically.

"We're in the beginning stages of a very big transformation," Chief Investment Officer Russell Read told the CalPERS board at a half-day educational workshop on Sept. 12.

The approach could involve a substantial portion of CalPERS' assets. As of June 30, CalPERS had about 8.4% of total assets invested in natural resource plays, Mr. Read said. Another 11.6% of assets are directly or partially affected by commodity prices, including utility, transportation, airline and chemical company securities.

Private equities provide a ripe opportunity for CalPERS to exploit burgeoning demand for capital. "It's certainly possible by the end of the decade that some 50% of (CalPERS') new private equity opportunities could be natural resource-oriented," Mr. Read told Pensions & Investments. CalPERS had $11.5 billion invested in private equities, as of July 31.

CalPERS officials plan to present a pilot project for board approval as early as the board's Oct. 16 meeting. Mr. Read said the allocation would be small, but declined to provide any further details.

The board will not tackle broader asset allocation issues until next summer. Mr. Read said a natural resource allocation would cover inflation-linked investments. Commodities not only provide strong diversification to traditional stocks and bonds but also provide a natural hedge against inflation, he said.

If approved, a shift to natural resources investing would mark the first major initiative of Mr. Read's tenure as CIO. He took over the top investment job at CalPERS on June 1.

Mr. Read is attempting to supply a vast demand for investment capital in natural resources.

Last year, the International Energy Agency, Paris, estimated $17 trillion will have to be invested in energy development between 2004 and 2030 to meet expected global demands.

George Manahilov, director, natural resources leveraged finance at Barclays Capital, New York, told the CalPERS board that private equity funds have become more important players in natural resources, but they won't be able to meet burgeoning capital needs. He estimated $50 billion to $60 billion in private equity assets are dedicated solely to energy investment.

For example, First Reserve Corp., Greenwich, Conn., last month closed a $7.8 billion private equity fund that will target 20% to 30% of investments on energy exploration and reserves. The bulk of First Reserve Fund XI LP investments will be in energy infrastructure, including businesses that manufacture equipment or service the energy industry, explained Kristin Custar, assistant vice president. The remainder of the fund will invest in alternative energy strategies.

Earlier, First Reserve funds focused more on energy-producing assets, but the costs of those investments has climbed, she explained.

Investors in the new fund include CalPERS, confirmed spokesman Brad Pacheco, who declined to say how much was committed to the private equity fund. As previously reported, the California State Teachers' Retirement System committed $300 million; Oregon Investment Council, $300 million; and Los Angeles County Employees Retirement Association, $30 million.

Sources said other investors include the CPP Investment Board, British Columbia Management Co., the State Board of Administration of Florida, the Teachers' Retirement System of Louisiana, the government of Singapore, the Washington State Investment Board and Minnesota State Board of Investment.

Commodity prices tend to run in long cycles that have sweeping implications for all asset classes, Mr. Read told the board.

From 1964 to 1980, commodity prices remained high, affected by rising inflation and interest rates and supply disruptions. From 1981 through 2000, interest and inflation rates fell and there was an oversupply of natural sources, leading to weak commodity prices.

The trend started reversing in 2000. But there is still plenty of time to invest, experts said. "This is only the beginning," Mr. Manahilov said.

Steven Strongin, global head of strategy research at Goldman Sachs & Co., New York, told the CalPERS board the investment situation has changed dramatically from 2000, when a simple investment in commodity futures would provide compelling returns. Now, opportunities lie across a variety of asset classes, he said.

Mr. Strongin said the situation was analogous to the start of the Internet or the personal computer era, when many new players emerged but the great majority of them failed.

It's impossible to know which companies will emerge as the real winners. "I can name 35 technological solutions, but I can't tell you which ones will grow large enough to matter," Mr. Strongin said. In the early stage of the personal computing revolution, "who would have thought that the key was selling a spreadsheet (program) and a word processor at the same time?" he asked.

The best opportunities are not with large, established energy players, such as oil and gas companies, but with entrepreneurial firms seeking to develop new technologies, such as ethanol or solar power, service providers, and infrastructure investment, such as gas pipelines, Mr. Read told the board.

When the personal computing revolution started, "IBM (Corp.) played a key role for five years but it was swapped out by other players," Mr. Read said.