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Commodities in CalPERS' Future?

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SACRAMENTO, Calif. (–Commodity futures have made it to the California Public Employees’ Retirement System agenda, but whether they will remain and become a part of a pilot program is yet to be seen.

The size of such a program has yet to be determined, but in its analysis, CalPERS’s staff assumed an allocation of 3% of fund assets, or roughly US$6 billion. That amount would dwarf the US$200 billion pension fund’s current allocation to hedge funds and its proposed shorting-selling portfolios combined.

“A size of US$6 billion would indeed be considered quite massive for actively managed natural resources programs,” said Hilary Till, principal of Premia Capital, a Chicago-based commodity derivatives firm. She added, though, that at this point the CalPERS documents only refer to passive index investments. Specifically, the program would be focused on beta diversification rather than alpha-seeking instruments such as hedge funds.

The allocation to commodities is being proposed as a way to complement the pension fund’s current portfolio. Providing a forecasted return of 6.5% annually, commodity futures would do little to boost the fund’s overall return, but would aid in diversification, particularly in the area of equity where the majority of the CalPERS portfolio is invested.

A US$6 billion allocation used in the staff’s risk analysis would be a substantial portfolio in the commodity markets, where the larger investment funds traditionally may hover between US$1 billion and US$2 billion.

The largest U.S. retirement system seems to be following in the steps of international pension funds like PGGM, a Dutch pension fund that invested 4% of its assets in commodity futures in 2000. In 2004, commodity investing was its best strategy with a return of 13%.

In its memo to the investment committee, CalPERS staff remarked, “The CF market is large and liquid and appears to be able to support an additional US$6 billion investment.” They state that with open interest on the futures and OTC market combined totaling US$750 million, it is a larger market than U.S. institutional real estate, but is still smaller than hedge funds, which weigh in at over US$1 trillion.

CalPERS’ staff believes that the open interest in the market may also grow if commodity producers hedged a larger share of production. Staffers plan to make a formal recommendation at the next investment committee meeting in April.

Contact Bob Keane with questions or comments at [email protected].

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