Pension funds, fund managers and hedge funds are increasingly using commodity derivatives to diversify their portfolios, according to a new study.
Consulting firm Greenwich Associates found in its latest 2008 Global Commodities Research Study that more than a third of investors in commodities have been active in these markets for less than three years, and more than one in 10 said they started investing in OTC commodity derivatives within the past 12 months.
The entry of new financial or speculative investors into global commodities markets is causing a dramatic run-up in prices, according to Andrew Awad, consultant at Greenwich Associates. The results of the study reveal that, in general, the growing ranks of commodity market investors consist of three types of organisations: pension funds, which use commodities as a portfolio diversification tool; European banks, which use commodity derivatives to structure retail products that they then sell to their retail customers and hedge funds, which use commodities as a source of alpha.
“Overall, about 55% of the investors participating in the Greenwich Associates study say they use commodity derivatives for diversification, including almost 85% of pension funds and fund managers,” said Frank Feenstra, consultant, Greenwich Associates, in a statement. “At the same time, almost 40% of the investors say they use these instruments to generate alpha, including nearly three-quarters of hedge funds.”
These motivations are reflected in the differing patterns of product use among various types of investors, the study said. Around the world, investors in commodities are most active in index swaps and plain vanilla non-index commodity swaps. Nearly 45% of participating investors said they invest in index swaps and 39% said they use plain vanilla non-index commodity swaps. About a quarter use OTC commodity options and 21% use structured notes with commodity underlyings.
“In general, fund managers and pension funds are more likely to invest in index options, while banks are more likely to use single-commodity swaps and structured notes,” said Woody Canaday, consultant, Greenwich Associates.
Between 20-30% of investors are active in OTC derivatives in oil and natural gas. Fifteen to 20% of investors use OTC derivatives in base metals and precious metals, and just under 10% of investors use OTC derivatives in electricity.