“Should Pension Funds Invest in
Commodities? If So What Are the
Implications for Them....and
Others?”
Thomas Schneeweis
Michael and Cheryl Professor of Finance
University of Massachusetts
March, 2012
1
Summary
• Take Aways
• Benefits of Commodity Investment
• Commodity Investment
• Issues in Commodity Investment
• Commodity Investment: Then, Now and Future
• How To Get Started
2
Take Aways
•
While it is impossible in a short synopsis to convey all of the benefits of commodity
investments, commodity investments have been shown to provide additional return
enhancement as well as risk reduction opportunities to traditional and alternative
investments.
•
Historically, indirect investments (e.g., equity ownership of firms specializing in
direct commodity market production) have been the principal means by which many
investors obtain exposure to this asset class. However, in recent years, the number
of investible commodity indices and commodity-linked investments has increased
dramatically. Going forward, commodity investment will be tailored to meet the
unique ‘return and risk’ concerns of investors (pension funds, endowments, …)
•
Today, and more importantly future commodity price relationships, may be poorly
represented by past price relationships (corn is no longer just a commodity). In
short, studies which emphasize past empirical relationships may be less important
that those which offer a detailed analysis of future return and risk relationships.
3
Benefits of Commodity Investment
Traditional Assets and Commodity Performance (1992-2011)
BarCap U.S.
HFRI Fund
SP GSCI
BarCap U.S. BarCap U.S. Corporate High
Weighted
1992-2011
Commodity Index S&P 500 Government Aggregate
Yield
Composite Index
Annualized Return
4.13%
7.81%
6.23%
6.43%
8.38%
11.45%
Annualized Stdev
21.52%
15.03%
4.38%
3.79%
8.99%
7.06%
Information Ratio
0.19
0.52
1.42
1.70
0.93
1.62
Correl: SP GSCI Comm. Index
0.22
-0.04
0.03
0.23
0.36
Barclay Trader FTSE
Index CTA
NAREIT
5.95%
10.39%
7.75%
19.12%
0.77
0.54
0.18
0.19
S&P Listed
Private Equity
11.08%
27.62%
0.40
0.31
Note: Commodity investment has been presented as a ‘potential’ means to provide additional return
enhancement as well as risk reduction opportunities relative to stock and bond investments and non-traditional
investments such as private equity, real estate, hedge funds and managed futures, as well as to portfolios of
traditional assets and various alternative investments especially in periods of poor equity performance.
4
Commodities Investment
• Not All Commodities Are Alike
• Past is Not Prologue
• What to Invest IN – Is There A Difference?
5
Not All Commodities Are Alike
1992-2011
Annualized Return
Stdev
Correlation (S&P 500)
SP GSCI
SP GSCI Energy
Agriculture Index Commodity Index
SP GSCI Grains
SP GSCI Industrial Metal
Commodity Index
SP GSCI Livestock
Commodity Index
SP GSCI Precious
Metal Commodity SP GSCI
Index
Petroleum
-0.8%
4.6%
-2.7%
6.0%
-1.1%
8.5%
9.0%
19.3%
30.8%
23.0%
20.5%
14.0%
16.5%
30.7%
0.26
0.18
0.24
0.42
0.06
0.05
0.19
Note: Each commodity sub index has its own unique risk and return characteristics as
well as its own unique diversification benefits relative to an existing investment
portfolio
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Not All Commodities Are Alike
Note: The sources of returns to commodity are a function of the investment form (e.g., commodity futures
are impacted by changes in spot prices (supply and demand) as well as changes in cost of carry and storage
issues). However, research has shown that those commodities have which are susceptible to supply
constraints have shown to have the potential for a positive expected return while those commodities for
which supply constraints are short run in nature may require a more active trading strategy.
7
Commodity Performance: Past May Not Be
Prologue
Note: There have been dramatic changes in commodity markets over the past twenty years. What is
surprising is that except for the period surrounding 2008, the band of historical volatility has remained
between 20 and 30% (rolling annual volatility). Similarly, the correlation of a diversified portfolio of
commodities (SP GSCI) with the S&P 500 has moved in a band above and below zero. Recently the
correlation is at the high end but investors should be aware of the changing nature of correlations patterns.
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What To Invest In: Is There A Difference?
• Go Public
• Equities/Mutual Funds
• ETFs/Closed End Funds
• Go Private
• Hedge Funds
• Private Equity Investment
• Go Green
• Commodity Futures
• Equities
• Go Index
• GSCI, DJ-UBS, …..
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Where to “GO”
2007-2011
Annualized Return
Stdev
Maximum Drawdown
Correlation (S&P 500 Energy Index)
2007-2011
Annualized Return
Stdev
Maximum Drawdown
Correlation (S&P 500 Energy Index)
2007-2011
Annualized Return
Stdev
Maximum Drawdown
Correlation (S&P 500 Energy Index)
SP GSCI
Commodity Index
-2.79%
27.51%
-67.64%
0.77
ABCI (Formerly
Known as BCI)
5.17%
15.73%
-34.29%
0.76
VANGUARD
ENERGY FUND
3.83%
27.53%
-55.48%
0.96
ABCI Green Index
TR
3.04%
24.54%
-48.67%
0.66
HFRI Sector: Energy
Index
-0.21%
17.86%
-40.46%
S&P 500 ENERGY
INDEX
2.71%
23.98%
-49.76%
1.00
S&P Global
Alternative Energy
Index TR
-13.89%
31.00%
-66.85%
MLM Commodities
6.69%
16.67%
-20.40%
0.85
0.78
-0.10
S&P Global Eco Index S&P Global Timber &
TR
Forestry Index TR
-7.31%
-4.27%
25.69%
29.43%
-57.89%
-65.58%
0.72
0.67
SP GSCI Energy
Commodity Index
-4.29%
33.01%
-74.57%
0.74
S&P Global Water
Index TR
-0.12%
21.08%
-50.21%
0.75
Note: There is a wide range of ‘commodity based’ investment vehicles, each with their own unique
return and risk characteristics. Difference in performance exist due to differences in the underlying
investment vehicle (futures versus equities), the trading process (production weighted indices versus
dynamically traded commodity indices), fund form (mutual funds versus hedge funds versus CTA) as
well as in product emphasis (diversified or targeted (green, timber, water..).
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Issues in Commodity Research: A Personal View
•
Who are Speculators and What are They - Many institutions and individuals hold commodities as hedge toward other asset
classes and while not buying and selling commodities based on commercial plans they do purchase commodities based on a
diversified “asset class’ business plan;. In short, is an investor who uses commodities as an indirect hedge to expected
portfolio risk a speculator. Moreover, in a global ‘demand’ market the marginal impact of Pension Funds is an open question.
•
Regulation and Second Order Impacts; A particular regulation may result in long term changes in markets beyond that
anticipated in original legislation or may have impacts on trading structures well after the initial reason for the legislation is of
no significance.
•
What Is Available May Not Be What You Want: Commodities may have a role in any individual or institutional portfolio but
users should detail desired return and risk exposures (e.g., for portfolios with investment in private equity (oil, ..) or
commodity firms – simple passive investments in index products may make little sense). Remember people sell what they
can not what they should
•
Misunderstanding of Causal Relationships in Commodity Markets: Simple statistical measures representing relationships
within and across asset classes my be that; too simple, and may hide the actual dynamics of commodity price movement.
How one comes to grips with the macro and micro processes dominating commodity markets is at the heart of
understanding the impacts of commodity investing.
•
Issues In Trading Structure: Few individuals can afford insurance against the 100 year flood. (1998 and 2008 may happen
again for different reasons) but the cost of insuring against a “black swan’ may have severe short run and long run costs.
•
Data Quality and Understanding: Again, be careful of any analysis without a full understanding of the data used (Example:
some studies compare futures prices to spot – but futures prices have low trading costs compared to spot. Some academics
have tried to show that futures lead spot but in reality the spot was moving that way all the time (just within trading cost
bands).
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Where to in the Future
•
New Investor Demand
Bill Gross Explains How To Make Money In A 'Delevering World‘ - (Reuters) - Bill Gross, who runs the world's biggest bond
fund at Pimco, said he favors high-quality, short duration and inflation-protected bonds ….. He also favors commodities
.(Gross: “Commodities and real assets become ascendant, certainly in relative terms, as we by necessity delever or lever
less. “) whose prices rise with inflation and are limited supply. (NEW YORK, March 27 | Tue Mar 27, 2012 8:56am EDT) Read
more: http://www.businessinsider.com/bill-gross-delivering-in-a-delevering-world-2012-3#ixzz1qK6Z9KZ6
•
New External (Non-U.S.) Demand
China's Sovereign Wealth Fund Is Looking to Invest in Commodities: Posted Feb 1st 2010 4:45PM by Connie Madon -Filed
under: International Markets, China, Commodities. China has a $300 billion dollar sovereign wealth fund called the China
Investment Corp. The fund has been investing natural resources which China needs to develop its economy. For example,
China has had talks with Brazil, the world's second biggest iron ore exporter and Mexico, the second largest silver producer.
In 2009, CIC made purchases in the following companies:
– It bought 17.2% of Teck Resources Ltd, Canada's largest base metals producer for $1.5 billion.
– It bought an 11% stake in a unit of Kazakhstan's state run energy company.
– Then it purchased 45% of Nobel Oil Group of Russia.
•
New Product Demands
The SP GSCI Index is twenty years old. In that period new forms of index and active portfolio based products have come
into existence as investor needs changed. Today there is an increasing demand for targeted commodity based products
(e.g., ETFs) that are both passive and active (dynamic rebalancing) in form. In addition there is an increasing demand for
‘Fund’ specific products (commodities without energy, green commodity products…..).
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How To Get Started/Who Do You Trust?
Internal Asset Management
•
•
•
•
Dependent on size and breadth of Commodity Investment
Four person commodity team – between $1 million and $2 million
Investment in personnel and office costs
Compliance costs
External Asset Management
• Consultants: Private equity, Advisors (external managers and fund based investment
vehicles)
• Question as to quality and knowledge of external consultants (e.g., the CFA offers little as
to commodity knowledge – The CAIA (Chartered Alternative Investment Program
(www.caia.org) offers background on range of alternative investments including
commodities but as CFA no active training).
Self Education
• Incubation Funds, Tracker Funds…… Find set of external products and create lower cost
tracker funds. Note current use of GSCI investment is due more to fact that GSCI has the
longest history as investment benchmark such that any deviation from GSCI as investment
vehicles adds tracker risk even if many active investors have created products with more
attractive investment characteristics than the SP GSCI.
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Appendix: What Are Commodity Markets?
•
Commodity markets: Commodity markets include markets for a wide range of raw or primary
products(oil, food, precious metals, etc.). Commodities are traded on a wide range of centralized and over
the counter markets both in the United States and Non-U.S. Markets. Commodities are available both spot
markets as well as though futures markets (in which they are bought and sold in standardized contracts) as
well forward and other OTC investment vehicles.
•
Direct Investment - Commodity Futures/Forward Markets: Commodity futures markets allow those who
expect to have or need that asset to establish a price and quantity ahead of time. Futures market attracts
hedgers who minimize their risks. Rather than make or take physical delivery, most futures players
eventually close their positions with offsetting trades. Spot and futures market prices that move too far
out of line do encourage some traders to make or take delivery, however, the threat of such arbitraging
generally drives spot and near-delivery futures prices together
•
Indirect Investment - Historically, direct commodity investments through futures markets have been a
minor part of investors’ asset allocation decision. In contrast, indirect investment (e.g., equity or debt
ownership of firms specializing in direct commodity market production) were historically the principal
means of obtaining claims on commodity investment. In recent years, however, the number of investible
commodity indices and commodity-linked investments has increased dramatically.
•
Active/Passive Investment: There is an increasing demand for financial products based on commodity
investment that provide commodity products with unique return (short term or longer term investment
profiles) or risk profiles (long short commodity, arbitrage, collar)).
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Background Information
There are a number of traditional and alternative investment indices used in this
analysis. For the more traditional indices it is assumed that the reader is familiar
with the investment index used: For background information on the commodity,
hedge fund, and CTA indices used the reader is directed to the following web
sites.
SP GSCI - www.standardandpoors.com/indices/sp-gsci
HFRI Hedge Fund Indices: www.hedgefundresearch.com
Barclay CTA Index: www.barclayhedge.com
ABCI: Alternative Benchmark Commodity Index (Formerly Known as BCI
Commodity Index): www.bache.com
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Disclaimer
• The securities and strategies referred to in this
presentation are shown for illustrative purposes only and
should not be interpreted as any form of investment
recommendation. The information contained in this
presentation has been obtained from sources believed to
be reliable, but their accuracy cannot be guaranteed. In
addition, the opinions expressed in this presentation are
the author, are subject to change and are likely to evolve
over time. This presentation does not constitute an offer
to sell, or a solicitation of any offer to buy, any product. If
any such offer or solicitation is made in the future, it will
be made only by appropriate written documents
containing specific terms, conditions, limitations and risk
factors.
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