Moving beyond GSCI

Edouard Dubuis
Head of asset management
• Invested assets: CHF25bn (€19.4bn)
• Swiss Federal Social Security Fund
• Responsible for the central management of funds and assets
• Pays all state pension and disability benefits
• Date established: 1948

We started to invest in commodities in 2007. The current strategic allocation to commodities stands at 3% - with a permissible bandwidth of 0-6%.
In 2010, we started a new approach to commodities, which means we now differentiate between alpha and beta investments. The 3% beta portfolio is a passive benchmark investment based on the S&P GSCI Commodity index, while the alpha portfolio, which consists of rule-based strategies, comes on top. Those rule-based strategies are based on the shape of the curve, the timing of rolling positions and on momentum.

In the second half of 2010, we issued the requests for proposals and selected seven strategies. As a result we have been ramping up the portfolio in the first few weeks of this year and we expect to gather some positive experiences by year-end. The analysis and selection of the strategies, as well as the collateral management, are undertaken in-house.

In the past we had different ways of investing in commodities. Some of the investments were undertaken in rule-based strategies via total return swaps. Others were invested in funds according to different benchmarks.

But we decided to streamline that; we opted for one benchmark, S&P GSCI Total Return US dollars, and put the whole commodity exposure on that base. Essentially we wanted to differentiate between what we invest in with that benchmark, the beta portfolio, and how we invest in the alpha portfolio.

Our main reasons for the move to commodities were that they bring diversification and a certain hedge against inflation, and to date they have fulfilled these expectations. We have used total return swaps because they are much more flexible and are tailor-made, which has its advantages. They also hold advantages in terms of costs.

In general, the investment strategy focuses on highly liquid investments to conserve the real value of the assets.

Our overall asset allocation this year is split into 10% Swiss franc loans, 20% Swiss franc bonds, 37% foreign currency bonds, 25% equities, 5% real estate and 3% commodities. Last year’s strategic asset allocation generated a return on investments of 4.3% - commodities returned 2.2%.

With the beginning of the year, the fund moved from operating as a single entity basis to a three-tier system, the main old age pension fund, a disability fund and a third fund responsible for maternity and military benefit payouts.

Andre Konstantinow
Head of manager selection
Barclays UK Retirement Fund
• Invested assets: £16bn (€18.2bn)
• Members: 250,000
• Closed DB, replacement hybrid scheme
• Funding level: 77% (Sep 2009)
• Date established: 1964

We have been investing in commodities for six years. Around 2% of the portfolio is invested in commodities. The invested amount is flexible and the trustees’ in-house investment team - operating under Oak Pensions Asset Management - has the flexibility to review exposures, depending on global markets and world events. The CIO, who provides the governance around this flexibility, oversees the investment initiatives.

We use passive and active commodity mandates, including futures, total return swaps, semi-passive funds and commodity hedge funds. The product categories represent a particular approach to holding commodities, such as short, medium and long maturity products in the semi-passive approaches and the alpha product in the commodity hedge funds. The split is roughly 60/40 in favour of passive.

There are two objectives behind this strategy: one is absolute return, in other words maximising returns from both alpha and beta in the commodity markets by capturing a wide variety of return sources; the second one is inflation protection.

The sources of returns in a passive strategy are cash, spot and roll return. An active strategy can also exploit returns from cyclicality, seasonality, cross-correlation and weather premiums. Active implementation uses both long and short exposures and benefits from active risk management. Therefore the new approach uses a number of additional return sources, namely commodity beta, optimised roll/spread returns, liquidity premium, momentum-based trading returns and manager-specific alpha.

We implemented this approach in 2010. Previously our commodities investments only consisted of exposure to the GSCI Total Return index. A tailor-made benchmark allows us to exploit a wide variety of sources of returns from commodity investing without having to worry about the tracking error.

The drawback of a passive strategy is that it must maintain long positions regardless of the commodity term structure. When the commodity futures curve is upward sloping, the roll yield is negative, which is to the detriment of the total return. Passive commodity futures indexes cannot avoid interim price crashes in individual commodity markets facing short-term disruptions.

Beta returns in commodities tend to be zero while maximising risk-adjusted returns is about making money while managing the volatility. While it is too early to say whether our objectives have been met, the early indication is that risk-adjusted returns have increased, with volatility under control and returns strong.

Tom Mergaerts
Amonis OFP, pension fund for self-employed medical professionals
• Invested assets: €1.3bn
• Participants: 25,000 active, 1,000 retirees
• Industry-wide DC scheme
• Date established: 1968

Our alternatives target is 7%, of which 4% is invested in hedge funds and 3% in commodities. At present around €33m is allocated to commodities via a UCITS III fund that follows the Dow Jones UBS Commodity index through an enhanced indexing strategy.

The pension fund entered the commodities world in 2006 by investing in two UCITS III exchange-traded funds (ETFs) offered by AXA. We chose exposure to the Goldman Sachs Commodity Index (GSCI) fund but as oil, at the time, represented around 70%, we decided to reduce the exposure to oil through combining the two funds by buying 50% in the GSCI fund and 50% in the Goldman Sachs non-energy fund.

However, we were not happy with the composition of the index, which is why we looked to enhance the strategy by moving to a more balanced index.

Under Belgian pension legislation, commodity investments have to be undertaken through fund structures. However, UCITS III funds are restricted on the proportion of futures they can hold with exposure to just one commodity - in other words, there is a limit on any single future exposure. This means that in order to keep their UCITS III status, GSCI-based funds have to cap some oil futures, which, as it is not a tracker anymore, results in additional basis risk for the investor.

Another problem with our first commodities strategy was that it was a pure passive investment, subject to the full effects of contango and backwardation. We then came across the Dow Jones UBS Index tracking fund by Goldman Sachs, whose components are more evenly balanced and which offers an enhanced strategy. It does not strategically roll all the futures at the beginning of the month, which enables them to shift or take positions on the curve, thus enhancing the rolling of the futures in the fund. We implemented this more active, index-based strategy in September 2010.

The main reason for including commodities in our asset allocation was that they are a portfolio diversifier. They also help to absorb inflation spikes, although we do not use the asset class as an inflation hedge. Correlation with equities is also low. Basically it is a type of commodity trading adviser (CTA) strategy, known for its favourable distribution features in combination with equities and bonds, which has proved to be diversifying for us.

But with only 3% invested, the diversifying effect on the portfolio is not that significant.