Pension Funds Embrace Commodities

One of the largest pension funds in the U.S. has positioned itself to take advantage of falling commodities prices. The $178.8 billion (as of November 17) California Public Employees' Retirement System (CalPERS) initially announced a $500 million pilot program for adding commodities investments in 2006. Last February, CalPERS went a step further by setting a target exposure rate of 1.5%, or approximately $2.67 billion of its current value, for commodities. Investors thinking of bolstering their portfolio with commodities should consider the following reasoning and commodities-focused investments.

Inflation Hedge
Commodities can be a hedge against inflation related to rising fuel and food costs. Higher oil prices raise the cost to transport everything from shipping freight to the prices individuals pay in grocery stores and at the pump. The pullback in oil prices and other commodities can be viewed as an opportunity to add commodities and commodities-related stocks to an investor's portfolio comprised solely of stocks. (Don't miss Curbing The Effects Of Inflation.)

Falling Commodities
Oil prices have fallen to $55.50 per barrel from their peak above $147 per barrel in mid-July. The United States Oil ETF (AMEX:USO) captured the downturn in oil prices by dropping 40.39% from the beginning of the year through November 17. Other commodities, including gold and agriculture tracked by the iShares COMEX Gold Trust (AMEX:IAU) and the PowerShares DB Agriculture ETF (AMEX:DBA), have also fallen 11.49% and 24.37%, respectively, while the SPDRS S&P 500 ETF (AMEX:SPY) has fallen 40.54% during the same period.

Commodities Guide Map
CalPERS uses derivatives to track the performance of the Standard & Poor's Goldman Sachs Commodity Index as part of its commodities investment strategy. Energy earns the lion's share of the investment weight while precious metals, including gold and silver, represent the smallest allocation. Investors should note that the suggestion for the livestock investment is an Exchange Traded Note and not an Exchange Traded Fund. The suggestions listed could help investors plot a similar commodities investment road map. (Be sure to check out Corporate Use Of Derivatives For Hedging.)

Final Thoughts
CalPERS' interest in commodities is grounded in its commitment to diversification beyond equities and fixed income. The historical non-correlation of commodities to equities may have gone bust during the most recent market downturn, but holding a basket of equities and commodities ETFs would have taken some of the volatility out of investor portfolios. As always, investors should consider a dollar-cost-averaging approach before beginning and implement a plan to rebalance their investments periodically.