Commodities may be latecomers to the diversification game, but market commentators suggest they are winning an increasing share of institutional investors’ portfolios.
Changes in the commodities market - driven largely by increasing demands from the booming Chinese and Indian manufacturing industries - have increased demand for commodities, and made them far more interesting, according to London-based asset allocator Seven Investment Management’s Justin Urquhart Stewart, who states that most commodities indexes were in decline before 2001. “Demand was flat. It was a bit Sleepy Hollow,” he adds.
Add increasing demand to rationalisation of the industry and fund managers “pulling it together”, and the once largely inaccessible asset class has been transformed into a vibrant market.
“There is a growing trend of pension funds investing in commodities. This generally due to frustration about performance in other asset classes,” says Urquhart Stewart.
“Pension funds are looking at alternatives.”
Goldman Sachs head of European GSCI investor sales, Arun Assumall, stated the firm had seen increased investment by pension funds in commodities over the past year.
“At the end of 2004, we estimate that $45bn (€38.6bn) was invested in commodity indices. Today we believe this number is closer to $65bn,” he says.
Assumall attributes this growth to a persistently positive tactical outlook and clients investing strategically.
“Negative correlation of commodity returns with financial assets plus high returns help to reduce risk and increase the overall returns of a financial asset dominated portfolio, and
subsequently improve Sharpe ratio.”
Assumall states there has been growth across the commodities spectrum, including indices and non-index products. He adds: “Bias has been towards energy because the outlook has been particularly bullish. But also over the long run, energy is most negatively correlated with financial assets.
“Energy has exhibited highest returns. Energy has had the greatest positive correlation with rising
The Goldman Sachs Commodity Index, which has risen roughly 27% this year, reflects this with its 80% weighting in the energy sector.
Meanwhile, Watson Wyatt senior investment consultant Alasdair Macdonald states the group had seen roughly £500m (e736m)worth of investment in commodities over the past year and a half in the UK alone.
“It is part of a wider trend of diversifying equities into alternative asset classes. Pension funds carry lots of risk from equity allocation. There is a switch from equities to others,” he says.
Commodities trailed behind hedge funds and property, for example, when diversification began between four and five years ago.
“Now they are more mainstream, popular, and there are more products on offer,” says Macdonald.
The senior investment consultant could not say whether commodities were a better investment option than hedge funds.
“They all have their advantages and disadvantages. They all slot into a framework of diversification. There are no killer asset classes out there.”
Urquhart Stewart states the transparency of commodities might be more favourable for pension funds as opposed to the “hope for the best” approach with hedge funds.
Assumall expects to see investment in commodities by all players continue to climb. “However, for pension funds in particular looking to invest strategically, it is very important to get exposure directly to the asset class through an index, for example, rather than via a commodity related stock.
“Commodity related stocks have exhibited more correlation with equity markets than commodity markets over the long run. Investors should buy directly into commodities, not commodity stocks, to diversify their overall portfolio.”
Urquhart Stewart also expects investment in commodities to rise significantly – potentially up to 15% depending on circumstances. “Equity is still important, but we are living in a world of ‘de-equitisation’, where the amount of equity around is shrinking,” he explains.