Big funds more wary of commods than ever

Carrie McCabe, CEO and Founder of Lasair Capital, speaks at the Reuters Global Hedge Fund and Private Equity Summit in New York March 25, 2009.

NEW YORK (Reuters) - Most big funds that have never touched commodities won't have the stomach for it now without adequate protection from volatility in the sector since last year's crash, an advisor to institutional investors said on Wednesday.

"Commodities are quite new to many large institutions and they are going to have to be presented in a format that institutions find digestible and ... not too extreme in volatility," said Carrie McCabe, an industry veteran who works with major investors, including pensions managers.

"Most institutions can't stomach a 20 percent market volatility," said the chief executive and founder of Lasair Capital Inc at the Reuters Private Equity and Hedge Funds Summit in New York.

"If you're sitting on a big pensions plan, with say a value about $20 billion, which is a good-sized plan, you just don't want to get caught on the downside of the market, though you want the upside. There are going to have to be strategies that offer better protection for capital," she said.

After years of being deemed too risky, commodities have emerged as a mainstream asset class. Some institutional funds, including the largest U.S. pensions manager Calpers, began investing passively in commodity indexes in recent years to diversify from stocks and bonds.

But those funds suffered last year as prices of energy, grains, metals, which hit record highs during the summer, crashed just months later from the global economic downturn.

Commodity prices have recovered lately, with oil and copper, for instance, trading about 20 percent above 2008 year-end levels. But the markets have also been volatile, swinging 10 percent or more on some days.

McCabe, formerly CEO of FRM Americas and Blackstone Alternative Asset Management, said returns from commodities could be enormous in coming years from the inflation expected to emerge from the trillions of dollars being spent on world economic recovery.

"In Washington, they are estimating that by 2011, the debt level will be about 70 to 80 percent of the overall budget. The last time we were at those levels was in the 1940s. So institutions will want to look at inflation hedges," she said.

Still, pensions, university endowments and other major funds may not want to restrict their commodities options to just passive, long-only index plays, particularly with such markets vulnerable to more slumps.

"Its back to basics. It's protecting capital and making returns that will matter," McCabe said.

She said those formulating commodity investment strategies for pension funds should look at the long-short equity strategies that such funds were increasingly drawn to. In a long-short equities strategy, an investor basically bets on higher prices for a stock when a firm's fundamentals look good and lower prices when its outlook sours.

"We find more and more corporate pensions plans looking at hedge funds using long/short equities strategies, because they just can't afford any more losses and they expect that to help them make money faster," McCabe said.

She said another reason institutional investors were choosing hedge funds and not just long-only strategies "is so they could be active in the management of risk."

(Reporting by Barani Krishnan; editing by Richard Chang)