A proposal to ban pension funds from investing in U.S. commodity markets threatens to further squeeze retirement plans whose funds are already lower because of a woeful stock market.
It could also result in two unequal types of pension funds: those that moved money into the sector early and those that missed their chance to diversify their portfolios with what is currently the best-performing asset class.
The missed opportunity would be for people who have yet to get into commodities and unable to partake in what has been a strategic asset class, said Eliot Geller, managing director and global head of commodity indexes at Jefferies Financial Products, co-owner of the Reuters-Jefferies CRB Index .CRB>.
The CRB, which tracks 19 commodity futures and is one of the most popular investment outlets for pension funds, is up 27 percent year-to-date.
The S&P 500 Index .SPX> of top 500 U.S. stocks, by contrast, is down by around 10 percent as the U.S. stock market heads to what could be its worst annual performance since 2001. U.S. bonds are doing better although benchmark yields hit five-year lows recently.
Analysts say the clear outperformance of commodities is naturally a magnet for investors, if they have not already moved into the sector.
But pensions may find themselves of out the game as U.S. lawmakers target them for purportedly contributing to the speculation that has driven up food and fuel prices.
Of the numerous Congressional proposals, one suggests pensions with assets of $500 million or more be barred from commodities, while others call for a blanket ban on institutional funds, including pensions, from the sector.
It would certainly hurt to take one tool away -- and a tool that can be important from a portfolio standpoint, said Karen Dolan, director of funds analysis at Morningstar, a firm that provides research on financial markets and alternative investments such as commodities.
To press their case, U.S. lawmakers cite the growth of index-related commodity investments by major funds to $260 billion compared with just $13 billion five years ago.
But analysts said most institutional investors devote only 3 to 5 percent of their portfolio to commodities and alternative assets such as real estate, compared with the 40 to 50 percent typically allocated to equities and the balance to bonds.
This means a pension fund with $500 million in assets will usually have up to $25 million in commodities, although the California Public Employees Retirement System, with $245 billion in assets, has $1.1 billion in the asset class.
The strategy is intended to minimize losses from stocks as commodities move to their own fundamentals and have historically rallied during bear markets in equities.
Analysts say the benefit of having commodities in a portfolio has become more evident this year as a streak of record highs in oil, gold and grains prices helped create alpha or gains beyond market expectations for some investors.
FINANCIAL HEALTH OF PENSIONS IN QUESTION
On the same score, the slump on Wall Street has been bad enough to wipe out the bulk of gains made by many pensions through 2007, casting doubt on the ability of some funds to meet future payouts and other financial commitments.
Asset losses coupled with decreasing interest rates during January 2008 reversed almost all of the 2007 gains, leaving the funded status just slightly below 100 percent at the end of the first quarter, said Milliman Inc, a firm that does research on employee benefits.
A Milliman study on the pensions of 100 U.S. public firms found their funded status improved by $85 billion in 2007, and fell by an estimated $62 billion in the first quarter.
U.S. state pension are not doing very well either.
Retirement plans in New Jersey and Kentucky both have unfunded liabilities totaling nearly $30 billion, according to recently published data.
Analysts said such data is proof that pensions need wider diversification opportunities, and argued that removing commodities from their plate would do the opposite.
Investment managers are looking to go out and find more alpha in order to satisfy their funding obligations because they may not be able to overcome the underfunding with just new contributions, said Gary Amelio, president for retirement systems at Ullico, an insurer for unions.
Shutting pension funds from investing in U.S. commodity markets could also drive them to look for diversification opportunities outside the country.
Somebody will open up a futures exchange in Dubai, Abu Dhabi or Malta and all the business from the institutional funds and pensions would go there and the U.S. would be the biggest loser, said Victor Sperandeo, a veteran commodities trader and president of Alpha Financial Technologies. (Editing by Matthew Lewis)