Authors: Iordanis Eleftheriadis, Ioannis Anastasovitis

Title: Can the commodity futures be used as effective diversifiers for pension funds investment portfolios? A literature review

Abstract

Pension Funds (PF) are considered to be financial vehicles as their size has been increased significantly during the last decade. According to OECD, the total amount of pension assets worldwide has almost doubled since 2009, exceeding the threshold of $50 trillion at the end of 2019. This trend is of great importance because their investment performance is related not only to the individual but to the social welfare as well. Through this prism, there is extended scientific research focused on the evaluation of investment strategies and risk management strategies adopted by various forms of PF.

The investment strategy of PF has turned into a crucial matter, as their managers have to take decisions in a low interest rate environment, within interrelated global financial markets, during turbulent periods of economy. In such a volatile macro-financial landscape, the trustees can allocate their pension assets in a wide range of traditional investment choices, such as cash, deposits, stocks, treasury bills, bonds and mutual funds. Under these conditions, there is the necessity for the design and implementation of the optimal investment strategy which combines successfully the maximization of portfolio returns with the minimization of risk.

The imposing by the regulators investment limits and performance regulations on pension funds’ activities, make the trustees’ mission even more and more complicated. Besides, there is a no common legislative framework among the countries through which the investment policy of PF is jointly regulated. The most essential constraints deal with a) the kind of investment means that it is allowed to invest the PF and b) the upper permitted limits of investing per asset class which cannot be exceeded.

Complementary to the traditional investment tools, there are many other assets which are classified under the general term of alternative investments. In this category are included private equities, private real estate, infrastructure, hedge funds and commodities. Nowadays, it is observed a significant raise of the proportion of asset allocation at this group of investment tools by the PF, of many countries. This is possibly interpreted by the need of PF for gaining increased returns without taking additional risk, in order to fulfill their pension liabilities and guarantee future pension payments. However, the investment in these categories of assets is prohibited in many countries and the relative legislation can be considered as a conservative one.

In this paper we investigate, from theoretical perspective, the potential benefits of the commodities and the commodity futures inclusion into a PF investment portfolio. According to the literature review, there is strong evidence that these alternative assets can be used by the managers of PF as hedging tools, providing to them advantages, in terms of risk diversification. However, further empirical research is needed in order to certify their beneficiary attributes. All in all, the results of our study could be useful for the PF trustees, during the construction of well diversified portfolios and for the pension regulators, in order to reexamine the existing investment restrictions.