More institutional investors are considering agricultural commodities as a possible way to help stabilize their investment portfolios in a volatile market environment.
That includes the €208.9 billion ($286 billion) Stichting Pensioenfonds ABP, Heerlen, Netherlands, and the £38.4 billion ($77 billion) BT Pension Scheme, London, which are both evaluating whether to expand exposure to agricultural commodities. Both funds currently invest in agricultural commodities as part of broader passive commodity indexation strategies.
Its unlikely that we would allocate simply to soft (commodities), but we may include it as a portion of an investment in a fund of funds, in which we would combine it with other (actively managed) commodity investments, said Andrew Raisman, marketing director of London-based Hermes Investment Management Ltd., which manages the BT Pension Fund.
Michel Meijs, spokesman for ABP, also said fund officials are studying the possibilities of increasing agricultural commodities but he declined to provide further details. ABP plans to increase its overall commodities exposure to 3% from 2.5%, while BT Pension invests 3% of total assets in commodities.
Consultants specializing in commodities said they, too, are advising more institutional clients on whether to increase exposure to agriculture. Although commodity strategies on their own are generally considered highly volatile, their negative correlation to equity and inflation-hedging characteristics can help offset potential losses in other assets classes, consultants and fund managers said.
What Ive seen is tactical exposure to agricultural commodities (by institutional investors), said Aoifinn Devitt, director of London-based Clontarf Capital, a consultant specializing in advising institutional investors on alternative investments including hedge funds, private equity, real estate and commodities.
Because commodities is such a hot investment, the belief is that (energy and industrial material commodities) has already run its course and agriculture commodities will be the second shoe to drop.
Less in the U.S.
Despite having been traded in the U.S. for more than 100 years, agriculture commodities is a relatively newer asset class for U.S. pension funds compared with some of their foreign counterparts, consultants said.
For example, the $242.7 billion California Public Employees Retirement System, Sacramento, only approved a pilot commodities investment program in December 2006. With initial funding of $500 million, CalPERS uses a custom benchmark that has about a 12% exposure to agriculture.
Commodities, in general, have long been recognized for the lack of correlation of their returns to the returns of other major classes and for their inflation-protection characteristics, spokesman Clark McKinley said in an e-mail.
No data are available on agricultural assets under management globally. However, a 2007 survey by Barclays Capital, London, estimates assets under management in all commodity products around $100 billion and forecasts an increase to between $140 billion and $175 billion by the end of 2008. The survey involved 240 institutional investors.
Higher demand for biofuels, along with global population growth and rising income levels in developing countries, are expected to contribute to a surge in food prices in the next 10 years, according to fund managers who cited data from the Food and Agricultural Policy Research Institute, Ames, Iowa. At the same time, a shrinking level of available farmland, water shortages and climate change have made production more costly, all of which affect the supply side globally, managers said.
Given that the objective of commodities is primarily as a diversifier and then, secondly, inflationary protection, then those looking at agricultural commodities today can find support from the 1970s, said Robert Greer, senior vice president and real return product manager at Pacific Investment Management Co., Newport Beach, Calif. Commodities indexes did well through not one but two oil price shocks.
The commodities indexes during that period did not have any energy in them, said Mr. Greer, author of The Handbook of Inflation Hedging Investments. Energy was included in indexes such as the S&P GSCI Commodity index in 1983. If they didnt have energy, then what did they have? They had agricultural and metals, he added. As of June 30, PIMCO managed $15 billion in commodities assets, the majority of which is benchmarked to the Dow Jones-AIG Commodity Index, which has about a 39% exposure to agriculture commodities.
On Aug. 9, when stock markets in Europe and the U.S. tumbled, prices in major agricultural commodities such as sugar, soy beans and coffee remained stable. The Dow Jones industrial average fell by 2.8%, and the S&P 500 stock index dropped 3% from the previous day. In comparison the Rogers International Agriculture Commodity Index, which tracks 20 commodities, declined by 1.01%. But prices for some of its main constituents slightly increased on the same day. Sugar closed at 9.83 cents a pound on Aug. 9, compared with 9.8 cents the previous day. Prices for soy beans closed at 8.58 cents per bushel on Aug. 9, compared with 8.55 cents the previous day, and coffee gained 1 cent, closing at 119.5 cents a pound.
We havent seen sharp falls, and in some cases, there was a slight gain, said Sudakshina Unnikrishnan, commodities research analyst at Barclays Capital. Compared to the base metals, in which prices are much more linked to the macro economy, you just dont have a similar thing happening for agriculture.
But agricultural commodities do have some important setbacks, including a lack of liquidity, consultants said. In addition, the large flow of investor money pouring into commodity strategies appears to have changed the fundamental pricing of commodity futures relative to the underlying commodities, said Alasdair MacDonald, senior investment consultant at Watson Wyatt Worldwide, Reigate, England.
Historically, investors are rewarded because commodity futures including agricultural commodities tend to be priced lower than the spot price. But commodity markets have been in and out contango, in which investors are paying a higher price for futures than the spot price. Different commodities markets will enter and emerge from contango at different times, generally depending on the level of inventory and what investors are willing to pay.
That, in isolation, doesnt mean commodities arent attractive, Mr. MacDonald added. But it does mean a higher probability of losing (money) from contango in the market and (makes it) less likely that any rise in prices will bail you out.
Christopher Wyke, product manager of emerging market debt and commodities at Schroder Investment Management Ltd. in London, said, I believe agriculture prices remain at historic lows, and factors such as global demand will continue to drive agricultural commodities upward.
The Schroder Alternative Solutions Agriculture Fund, which was launched in October for institutional investors and has $1 billion in assets under management, returned 13.92% gross of fees in the eight months ended June 30. In comparison, the Rogers International Agricultural Commodity Index returned 4.06% for the same eight-month period.