UK - Commodities are poised to become a mainstream investment class for pension funds in Europe and in UK, according to well-known market analyst.

“There is a very general broad interest in the sector among pension funds and other institutional investors. It is partly based on the fact that returns have been very good over the last 18 months,” said Barclays Capital’s commodity markets strategist Kevin Norrish.

He explained that commodities’ returns had been “significantly better” than the benchmark bonds and equity indices. The asset class, according to Norrish, is gaining momentum.

Referring to crude oil, Barclays’ Norrish said: “I think the arguments for oil are particularly strong. Returns in any investment in oil over the past 18 months or so would be very, very high indeed.” Crude prices have hit record highs in recent days on supply concerns following attacks in Saudi Arabia.

Citing the Goldman Sachs Commodity Index, which is 67% weighted towards energy products, he said that many of the investment products available tend towards energy exposure.

But he argued that that it was ‘unusual’ for pension funds to invest in a single sector of the commodity business and that they prefer indices that include exposure to a number of commodities such as precious metals and agriculture to spread risks.

“Strategic benefits” were a further reason why institutional investors in continental Europe and the UK were gradually showing more interest in the commodities market.

In the US, Norrish suggested, there was “a lot more flexibility on the part of institutions” but he added things were changing in Europe with big pension funds like the Dutch health care pension fund PGGM and the civil service scheme ABP getting into the market.

Recently it emerged that ABP is targeting a strategic allocation of 20% to “alternative investments” including commodities, along with hedge funds and other assets. And PGGM, which has 4.2% of its portfolio in commodities, said the asset class returned 23.3% in 2003. Dutch metals industry fund Metalekro has said it will allocate 700 million euros, or five percent of its assets, to commodities.

“UK pension funds are probably a little less up the curve, but they are actively considering moving forward in commodities, so I think it will happen. I think commodities are in the process of becoming a mainstream asset class.”

But he added there was still a need for “education” on how the asset class works. Asked whether he would recommend commodities to pension funds, Norrish answered: “We think there is a strong strategic argument to doing so.”

“A lot of the pension funds which have gone into the sector have had extremely good experiences.”

Mike Amey, responsible for UK bonds at Pimco Europe, put the oil price surge in a broader economic context. He told IPE: “On the liability side, the issue that many pension schemes would have would be to what extent higher commodities prices are linked to higher inflation.”

“On the basis that in many pension schemes the pension payments are linked to headline inflation, so a sustained rise in the oil price would probably be net-net unhelpful, I suspect."