Factors ranging from rising inflation to the coming “green transition” help make a case for increasing pension plans’ exposure to commodities.
By Ed McCarthy
The post-pandemic economic recovery has arrived, and inflation is accompanying it. Canada’s reported annual inflation rate was over 3% for both May and June, and the Bank of Canada estimates it will remain at or above 3% for the rest of the year. U.S. prices are running even hotter, with the consumer price index (CPI) up 5.4% from June 2020.
This inflationary spike has been reflected in commodities’ price indexes. At the beginning of August 2020, the S&P GSCI index was at roughly 345. By August 2, 2021, the index had climbed to 533, and its 55% gain significantly outperformed the S&P 500 index’s impressive 33% increase.
A Bifurcated Industry
Peter Grosskopf
Increased allocations to commodities are a traditional response to higher inflation. Canadian pension plans’ exposure to commodities has varied over time, according to Peter Grosskopf, chief executive officer of Sprott, a global asset manager specializing in precious metals and real assets investment strategies headquartered in Toronto. In the aggregate, plans were probably overexposed to the sector 20 or 30 years ago, but now they are underexposed, he maintains.
That condition could be changing, however—Grosskopf says that he has started to see a few Canadian plans increasing their commodities exposure. “The very first leaders started to get inflation protection worked in, call it one to two years ago,” he says. “It’s certainly not been a landslide. These are early days for the Canadian plans, I think.”
According to the Pension Investment Association of Canada’s 2020 Asset Mix Report, pension plans had a portfolio exposure of roughly 5% to commodities. But the average masks a bifurcated market, says Tim Pickering, president and chief investment officer of quantitative alternative investment managers Auspice Capital Advisors in Calgary. Pickering uses a barbell example in which at one end, more sophisticated plans understand and hold commodity positions. At the barbell’s other end, plans that are still “coming up the curve” are much less likely to invest in commodities.
Part of that reluctance stems from commodities’ uneven performance in recent decades. Although the S&P GSCI index has been hot lately, investors will remember that from June 2014 through Jan 2016 the index dropped about 58% and the index’s performance remained volatile after that period. “Commodities have been out of favor for the better part of the last decade up until 2020,” Pickering notes. “I think you’ve got some recency-bias, both retail and institutional, where investors have sort of stayed away.”
Another cause for hesitation is that commodities are a fairly sophisticated area, Pickering adds: “It’s outside of the traditional balanced fund equity and fixed income world. So, there is expertise required either in-house or from external managers.”
In Grosskopf’s experience, plans traditionally have not worked extensively with external commodities managers. Canadian plans, especially the largest plans, have generally staffed their own areas when they want to get deeper into commodities, he says: “They haven’t farmed out a lot of capital in the commodities area, to my knowledge.”
So Why Invest Now?
Tim Pickering
Grosskopf and Pickering both maintain that the recent upswing in commodity prices is not “transitory,” to borrow the U.S. Federal Reserve’s new buzzword. Grosskopf believes that higher inflation and financial assets’ extended prices helps make the case for gold, which he describes as a good hedge for other financial markets. Metals and minerals will always be somewhat cyclical, he says, but these markets have experienced underinvestment for at least the past 10 years. Combine that underinvestment with money supply growth and stimulative economic growth policies and the result is a compelling case for minerals, Grosskopf says.
Pickering similarly cites multiple factors in building a case for increasing exposure to a broadly diversified range of commodities, including inflation-protection, portfolio diversity and the potential for experienced managers to add alpha. But he also cites a more recent development that he believes is very important: the “green transition.” “(It’s) the idea that we need to do things in a globally responsible way; from an environmental perspective we need to build back better,” he explains. “We need to spend money on infrastructure, but we’re going to do it in a better way, considering ESG and the green alternatives.”
You can’t build back better without commodities, Pickering argues. He cites the example of turbine wind firms, which require large amounts of metal, copper wire and concrete. “Those are commodities,” he points out. “And so, this green transition and this post-COVID build-back-better greening of the world can’t happen without commodities.” The result of this global activity could put commodities back in “an incredible light for the next 10 or 20 years,” he adds.\
Be sure to join us at The CAiP Alternative Investments Forum, an in-person event September 21-23, 2021, in Montebello, Q.C., where leading experts and top pension fund managers from across Canada will offer insights into new opportunities and risks in the alternatives markets.
Ed McCarthy is a longtime financial writer and author of three books, including “Foundations of Computational Finance with MATLAB.”
