As the bull market in equities began to fade in 2000, investors at Dutch pension fund PGGM began to hunt for new places to put their money. With the stock market floundering, PGGM money managers looked to diversify by investing in a sector with a negative correlation to equities. They also wanted something that would provide a hedge against inflation. So PGGM managers decided to try commodities. "We're always on the look-out for new possibilities," says Jelle Beenen, manager of commodities and quantitative strategies at PGGM in Zeist, the Netherlands. "As a stand-alone investment, commodities don't make much sense. But it makes enormous sense in the portfolio context."
In fact, commodities didn't make sense that first year; PGGM lost more than 30% on its investment in 2001. But since then Beenen and his colleagues couldn't be more pleased. While equities have stagnated, the fund's portfolio of investments in a range of commodities, including energy, agriculture, and industrial metals, has posted hefty returns -- more than 30% in 2002 and 23% in 2003. This year the investments are scoring double-digit gains once again. Commodities make up just 4% of PGGM's $68 billion portfolio, but the gains have helped the fund's performance. "It's useful to have an asset that performs well when our other assets aren't," says Beenen, whose fund serves 1.8 million clients.
PGGM is not alone. More than 100 institutional investors in Europe have diversified into commodities, market analysts say, including pension funds, insurance companies, foundations, endowments, and private banks. It's a seismic shift for most of the funds. Many North American funds have also moved into commodities, including the Ontario Teachers' Pension Plan, the Missouri State Employees' Retirement System, and Harvard University. Some, like PGGM, invest in over-the-counter derivatives that track the performance of a commodity index. Others buy individual futures contracts that collectively mimic such an index.
The money is pouring in. According to Goldman Sachs & Co. (GS), investors have about $25 billion committed to tracking the performance of the Goldman Sachs Commodity Index. That's triple the $8 billion investors benchmarked to the index in 2000. "Commodities have been accepted as an asset class," says Stefan Weiser, executive director of fixed income, currency, and commodities at Goldman Sachs International in London. "Interest has doubled and tripled over the last couple of years."
A VOLATILE MARKET
But are commodities really the kind of investment a conservative, cautious college endowment or pension fund should be putting its money in? After all, commodity prices can be extremely volatile. During the Asian financial crisis of the late 1990s, demand for raw materials sputtered, and prices fell. As a result Goldman's index slumped 36% in 1998. Then in the wake of the tech crash, commodities took another blow, with the Goldman index plunging 32% in 2001.
Much of the current enthusiasm is based on very recent history. Prices of many raw materials have surged on a combination of strong demand from China and geopolitical uncertainty. Oil prices, for example, have punched through $50 a barrel this fall. Likewise, aluminum prices hit nine-year highs in early October.
For investors in the sector, that's great news. Take Stichting Pensioenfonds ABP, the largest pension fund in Europe. Since 2001, the Dutch institution has committed 2.5% of its $195 billion portfolio to the sector via futures contracts and over-the-counter derivatives called total return swaps, which transfer the execution risk of trading commodities to the investment bank on the other side of the transaction. In the first half of 2004, commodities were the best performers in the fund's portfolio, posting a gain of 13%. Says Frank H. Asselbergs, fund manager at Heerlen-based ABP: "We're in commodities for the long haul."
THE HARVARD TOUCH
And can the vaunted investors of Harvard University be wrong? The school, which has a $22.6 billion endowment, boasts one of the best investment records of any U.S. institution, including an average return of 11.8% over the past five years. Harvard Management Co., which handles the endowment, has been investing in commodities for over a decade and now has 13% of its funds in the sector. The return in commodities for fiscal 2004 was 19.7%. Unlike critics who argue commodities are overly risky, Harvard's managers contend that diversification beyond stocks and bonds and into assets such as real estate, private equity, and commodities actually improves returns, relative to risks, over time. And so far, they've been right.
Even those involved in commodities trading, however, admit that it's not the kind of safe, conservative investment your father's pension fund might have made. "Commodity trading can be remunerative, but also risky," notes Michael Overlander, chief executive of Sucden Ltd., a commodity and financial futures broker in London. "It's not for the fainthearted." In mid-October, for example, copper prices plunged on worries that demand from China was tapering off. But as the pressure mounts for pension managers to maximize returns, risk becomes part of the game. In commodities, it has been a nice ride for a number of years. Money managers only hope there aren't too many casualties during the sector's next plunge.
By Laura Cohn in London, with William C. Symonds in Boston