While a number of Nordic pension funds have been investing in commodities for some time, interest in the asset class has spiked more recently. The rise in commodity prices, not only from increasing energy prices but also from escalating food prices, has made even the most reluctant investor begin to take notice of commodities or at least wish they had boarded the train.

When deciding to take on the asset class, there are a number of approaches to consider. While most pension funds choose to invest by following a broad index exposed to a large number of commodities, others argue for a more specific strategy, such as investing in an active fund or only investing in one specific commodity.

George Cheveley, co-portfolio manager at Investec Asset Management, says there has been a recent shift in interest from pension funds due to the increase in commodity prices. And there are indications that the outlook is good, since a negative or uncertain outlook for other asset classes has historically been good for commodities. Inflation is also positively correlated with the asset class.

Investec is bullish about the demand for commodities, which is not only boosted by growth and development in countries like China and India, but also by demand for improving infrastructure in the western world.

“Demand growth rates have returned to levels of the 1950s and 1960s when there were high average prices and a huge amount of investment opportunities. Back then, there was huge demand from the urbanisation of western Europe, Japan, Korea and also the US boom and we are returning to a period similar to that,” says Mr Cheveley.

But no matter how convincing the prospects for commodities may sound, the main reasons for taking on the asset class does not, however, seem to be for good returns. Instead, it is the diversification benefits that most pension funds are mentioning as the main motive for taking on the asset class.

“Diversification is the main reason,” says Henrik Gade Jepsen, chief investment officer at ATP, the DKr440bn (€59bn) Danish supplementary pension fund, which is a sentiment echoed by all other pension funds.

However, there seems to be some uncertainty of how to take advantage of the opportunities and many funds have been hesitant about how to invest. Kåpan, the SKr33.3bn (€3.55bn) Swedish pension fund for government employees, has been struggling to find a good strategy for taking on commodities.

“We looked at different indices, but were unsure about what we would actually get from [commodities]. We just weren’t certain how much real exposure to the actual asset class it would bring us,” says Gunnar Balsvik, Kåpan’s chief executive officer.

After contemplating different strategies, Kåpan finally decided to start investing through hedge funds and equities. The hedge funds are focused on trading in commodity futures and it also has some funds with exposure to listed companies.

Keva, the €24.3bn Finnish local government pension fund, has also been hesitant. The decision to take on the asset class was based on its ALM study from two years ago, but it only started investing last December.

“We’ve been quite cautious and had to study the different options and are still considering different ways of investing,” says Timo Viherkenttä, deputy CEO at Keva.

The fund is investing in passive products, but is also looking at other ways to access the asset class. Its relatively modest allocation has, however, been the fund’s best investment and returned around 25 per cent over the past six months.

Varma, Finland’s largest pension insurance company with €28.7bn in assets, has also decided to jump on the commodity train during the beginning of the year. Its CIO Risto Murto says its investments, which are index-linked, have so far been limited.

Having a more passive investment seems to be one of the most common routes for investing in commodities. But, while many pension funds are putting money into indices and are opting for passive long-only investments, some argue that investors need to start taking a more active approach.

“Passive indexed investments with different weights in different sectors were a strategy that worked from around 2002 until recently, when prices were rising for all kinds of commodities,” says Mr Cheveley.

The other attraction was that it gave investors non correlated returns, which was very attractive for pension funds.

“But there have been different movements in different kinds of commodities. In the last couple of years, only some prices have been going up, such as lead and oil, and we expect that to continue. Our view is that you want to take a more active strategy, for example by hedge funds that can go short as well as long,” Mr Cheveley adds.

Another problem is that passive investments do not give exposure to all commodities and Mr Cheverly mentions potash and some metals as very difficult to get exposure to through indices.

A third and increasingly popular route is investing through exchange-traded commodities (ETCs), which are listed funds tracking different commodities. Like exchange-traded funds, ETCs match the performance of an index and can be traded in the same way as shares. Emil Petersen, head of the Nordic and Baltic region at the firm, says they have received significant interest from the Nordic region.

“ETCs give a pure exposure to commodities. Some of its other advantages are the liquidity of the product and the simplicity by which you can buy it,” says Mr Petersen.

ATP is one of the Nordic region’s most daring investors in commodities, with 5.5 per cent of its assets committed to the asset class. The fund is investing purely in oil and has excluded all other kinds of commodities.

Finnish Varma, on the other hand, has been trying to restrict the role of energy. In its index-linked investment, energy investments make up no more than a third of the assets.

“We wanted a broader commodity exposure. The energy sector has performed excellently, but we made a specific decision to have a more diversified basket of commodities, which isn’t dominated by one single sector,” says Mr Murto.

He has a point. There is little disagreement about the high risk and volatility in commodities and, unsurprisingly, many spread their investments over several different types. Mr Gade Jepsen at ATP, which has more than 5 per cent allocated to oil, admits that it could be perceived as risky having such a large allocation purely to one commodity class.

“But it’s riskier to have a very concentrated portfolio with 60 per cent or more allocated to equities. We have a portfolio with a balanced risk allocation to five broad asset classes of which oil is one, so a fall in oil prices would be expected to be mitigated by gains on our other investments,” he says.

However, not everyone is convinced about investing or that the timing for moving into commodities is right. Sampension, the €12.5bn Danish pension management company, has put its planned move into commodities on hold. Henrik Olejasz Larsen, chief investment officer, says: “We wanted to invest in commodities, particularly ones related to energy, but had been caught off guard. Prices became so expensive that these investments had to be delayed.”

Others, like Valtion Eläkerahasto, the €12.1bn Finnish state pension fund, still have to make a decision. Timo Löyttyniemi, managing director of the fund, says that they will take a look at commodities as well as other asset classes in the future, but that it is too early to say if they will invest or not. In the meantime, it is getting some exposure to commodities through its equity investments, along with other still undecided investors.

Case study

ATP, the Danish supplementary pension fund, probably has the Nordic region’s boldest strategy for commodities. Not only does it have a significant allocation of 5.5 per cent, but it has also chosen a different strategy to most other pension funds. It invests purely in oil and has excluded all other kinds of commodities.

“Oil has had a low or negative correlation to other assets and thus can be expected to mitigate the swings in other asset classes,” says Henrik Gade Jepsen, chief investment officer at the fund.

The DKr440bn (€59bn) fund began in 2006 by investing in oil equities, but gradually changed to oil-indexed bonds where returns are linked to an index of oil futures.

“We prefer investing in oil-indexed bonds, which gives us the purest exposure to oil. Investing in oil equities was clearly preferable back in 2006, but not now,” he says.

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