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BENEFITS BEAT
Commodities: Second Chance for Pension Funds?
Diversification paid off — and there are more opportunities ahead.
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Now that the price of oil has fallen by $30, from a peak of $147 per barrel, and the global commodity bubble has begun to shrivel, newspapers have stopped running stories about pension funds manipulating the markets. Congress has ceased its hearings on oil-price manipulation now that the speculators are driving the prices downward, not upward. The dollar has rebounded, and domestic equity markets have improved a little. If anything, there is a little fear in the commodity markets amid talk of a global slowdown. This might therefore be a good time for pension fund trustees to start revisiting their long-term plans for portfolio diversification and inflation hedges.
There are strong reasons for pension funds to operate widely diversified, global portfolios that include alternative assets including commodities. With liabilities that often include planned and unplanned cost-of-living allowances, pension funds need to invest wisely to protect their purchasing power. This includes both international investing to gain a currency advantage when the dollar loses its value in inflationary periods, as well as commodity and "real asset" investments such as timberland and real estate to provide a hedge against outright inflation.
Some public pension plans have done remarkably well at diversifying, as I reported in last month's column. As June 30 investment returns dribble in from individual plans, there are now some interesting stories to tell.
One that I like the most is the 2008 success of the Missouri State Employees Retirement System. Headed by the widely respected Gary Findlay, the recently reported MOSERS investment returns were amazing — the fund actually made money in a down market over the past year. MOSERS' story is a classic tale of the benefits of diversification: The fund had money placed in non-conventional assets (commodities, inflation-indexed bonds and timber), and those extraordinary gains offset losses in traditional investments like the U.S. stock market.
Looking forward, the recent sell-off in commodities has only begun to attract the average newspaper reporter's attention. I fully expect us to soon see news reports that public pension funds are now losing money on their commodity investments in the third quarter. With the global economy showing signs of slowing, and the potential for a spreading malaise, there is a clear risk that commodity prices will fall further and lose their appeal as offsets to losses in other markets. At some point, hedge funds may bail out and drive prices below equilibrium. Cynical critics will then say that they "told us so," and that these new-fangled instruments should be banned for the damage they do to the economy in bull markets and the losses they suffer in bear markets.
I disagree. If anything, the current lull in commodity prices will likely be a short-term correction in a long-term, multi-decade bull market. That is not to say that oil prices could not plunge below $100 to the lower levels I had suggested might be a floor in my New Year 2008 column on markets and investments. But if they do, that would clearly be a great opportunity for the public pension funds that have not already made full portfolio allocations to commodities to begin ramping up their positions. Demand for raw materials from India and China will not wither away for long, even if the world experiences a global slowdown. Once the froth is washed out of these markets, a renewed emphasis on alternative investments would seem very prudent.
For public pension plan executives and investment officers, it's time to review long-term plans for portfolio diversification and take their best ideas to their board for action in coming months. A dollar rally would seem an especially opportune time to be moving in the other direction for long-term inflation-hedging purposes. Some boards may decide to wait to until they have a clear sense that the global bottom has been hit before they pull the trigger, which I cannot dispute, but the advance planning and investment policy work should be completed in 2008.
Girard Miller, an analyst of benefits and investments with 30 years of experience in the public, private and nonprofit sectors, can be reached at Girardinmalibu@charter.net. His general market observations and institutional investment strategies are his own and should not be construed as investment advice or recommendations concerning specific securities.
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