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London: Sharp falls in commodity prices have yet to cause an exodus by pension fund investors from raw materials but the credit crisis could prompt a shift to simplicity and away from complex derivatives.
"We haven't seen them [pension funds] coming out yet and we don't anticipate it," said Eric Kolts, vice-president, Commodity Indices at Standard & Poor's.
But he said he believed investors would look for simpler products.
Pension funds, which traditionally invest for the long term, have begun investing in commodities in the last few years, attracted by their ability to diversify portfolios.
Last month, US pension fund Calpers said it was not making any drastic changes to its commodity investments, which total about $1.3 billion.
Barclays Capital said on Thursday that total investments in commodities has fallen to $210 billion, from $270 billion in the third quarter.
The bank said investors exposed through indices were mainly the ones seeking to exit, including hedge funds and active investors, while institutional investors had been more stable.
Commodity indices have been one route investors have used to access the asset class and commodity indexes have proliferated during the commodity price boom.
Benefit
The more well-established commodity indices are likely to benefit in current market conditions.
"Several banks will continue to make markets in indices, but it's not the case they will make markets in all of them," said Kolts, speaking on the fringes of Commodity Week conference.
Investors traditionally have used commodity swaps - a form of over-the-counter (OTC) derivative - to make investments in commodity indices.
But the credit crisis has hit the OTC commodity swaps markets, where investment banks have traditionally been big players.
"While the pension funds that held swaps have not, to my knowledge, lost money, some significant ones are rethinking the counterparty risk of the OTC market," said Douglas Hepworth, director of research at Gresham Investment Management.
In Europe, investors have also gained access to commodities via structured investment products.
But the credit crisis could make investors shy away from complex financial instruments at least in the short term. "Will derivatives become a dirty word? That remains to be seen," said Kolts.
"Investors will be more willing to look at plain vanilla commodity investments and first generation index products."
Fallout from the credit crisis has also meant that there will be fewer banks active in commodity swaps markets. "Funds that still want their commodities via swaps are being challenged by the loss of several significant counterparties," said Gresham. He said some investors were potentially considering commodity futures instead, as a route into index investments.
Futures markets are regulated by an exchange and backed by a clearing house, which alleviates counterparty risk. But buying certain futures contracts could expose pension fund investors to potential physical delivery of the commodity.
"Some investors may be considering using futures instead of swaps," said one executive from a commodity investment fund. "But I suspect most of those who have been using swaps to get index exposure will have a bit of a learning curve."
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