WSJ -- Pension Funds Cut Back On Commodity Indexes ..................................................................
[ This is really good news.
If and when we get rid of the last $133 billion of "stupid" money,
then commodity futures can go back to being close to their "textbook" purposes :
"price discovery" / hedging mechanism / economic indicator / etc.
Jon. ]
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February 5, 2013, 9:08 p.m. ET
Pension Funds Cut Back On Commodity Indexes
By IANTHE JEANNE DUGAN
Pension funds and other institutions are retreating from popular investments linked to commodities after finding they did little to protect their portfolios against inflation risk and the unpredictable returns of stocks.
Investors have yanked nearly $10 billion from tradable indexes tied to energy, food, metals and other commodities after two years of record outflows. That leaves about $133 billion, said Kevin Norrish, a managing director at Barclays PLC. BARC.LN +1.29%
The trend is accelerating this year, analysts and investors said, driven by lackluster returns and looming U.S. regulations that could make these investments more complicated and costly. The reversal could affect the way commodities are traded and temper price swings in everything from cereal to gasoline to gold, some economists said.
Among those scaling back is the California Public Employees' Retirement System. Calpers, the nation's largest pension fund, pulled out 55% of its holdings in commodities indexes in October, after losing about 8% annually over five years, according to the fund's most recent financial statement. That left $1.5 billion of Calpers's assets in commodities indexes, 0.6% of the fund's total. The money was switched to inflation-linked bonds, under a policy that allows Calpers to make quick moves within investment areas based on market conditions, a spokesman said.
Calpers helped pioneer pension funds' push into indexes that track metals, wheat, energy and other commodities. Unheard of a decade ago, the indexes held $155 billion at the end of 2010, up from $65 billion in 2008, according to Barclays.
The money mainly flooded in from big institutions, such as pension funds and college endowments, embracing commodities as a diversification tool and a hedge against inflation risk. Commodities traditionally have delivered modest returns, in line with inflation, and are disconnected from the gyrations of stocks and bonds.
But the new money turned the market on its head. Many commodities seesawed beyond traditional supply-and-demand patterns, and some economists blamed these new "index speculators," who had no stake in the underlying commodities.
Farmers, airlines, oil companies and other producers and users found it more difficult to use futures contracts for their original purpose - to protect themselves against price swings.
The government has been wrestling with limiting investments by speculators. Separately, the financial-regulatory-overhaul law could increase costs and add complications by requiring Wall Street dealers to use a clearinghouse to settle derivatives transactions, including those connected to commodities indexes.
The indexes, meanwhile, have produced smaller returns and the wild price swings that investors were trying to avoid. In May, the Teachers Retirement System of the State of Illinois cited "volatility of commodity investments" in deciding to move $800 million in a $3.5 billion portfolio to "strategies that better protect TRS from inflation."
The performance troubles are evident in the S&P GSCI - formerly known as the Goldman Sachs GS +1.99% Commodity Index - a benchmark that tracks a basket of contracts linked to energy products, precious and industrial metals as well as agricultural and livestock products. That index lost about 33% over five years, compared with inflation of more than 6%. Those who invested in another popular index, the Dow Jones-UBS UBSN.VX +0.06% Commodity Index, lost a total of about 25% overall over five years. The declines stem partly from the way commodities contracts work. Unlike stocks, commodities contracts expire, typically monthly or quarterly, and then need to be rolled over into new contracts.
Speculators account for more than half of futures contracts in certain commodities, according to the Commodity Futures Trading Commission. But signs of cooling abound. In April 2012, for example, investors held 225,869 contracts for a wheat traded in Chicago, a record. Now, they are down to 144,487 "Chicago wheat" contracts, the lowest point in several years.
"Calpers turning around and getting out is sending this signal to other institutions," said David Frenk, research director for Better Markets Inc., a Washington-based advocate of financial change. "There is a huge transformation starting to take place."
The group has been a critic of index investing, arguing that pension funds are risking losing money and influencing prices of underlying assets.
Mr. Frenk flew to California in November 2010 to urge the California State Teachers' Retirement System to reconsider an investment of about $2.5 billion it was considering making in commodities, including the DJ-UBS, minutes of the meeting show. The pension fund allocated just $150 million but hasn't invested the money. Given that the index has lost 13% since the meeting, Mr. Frenk estimated, "they saved about $300 million."
Also on the sidelines is the Los Angeles Fire and Police Pensions, which put aside 5% of its $15.2 billion for commodities. So far, though, it has invested only in publicly traded commodities companies. "We haven't gone into indexes," said Tom Lopez, chief investment officer, "but the plan is to be there."
Index investing continued slowing this year, said Michael Lewis, a Deutsche Bank DBK.XE +1.44% analyst. "The role of commodities as a diversification strategy is being questioned because of an extreme market distress."
Write to Ianthe Jeanne Dugan at ianthe.dugan@wsj.com
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