Funds favor "plain vanilla" in commodities

By Jane Merriman - Analysis

LONDON (Reuters) - 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, U.S. 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 total investments in commodities has fallen to $210 billion, from $270 billion in the third quarter.

The bank said investors exposed through indexes were mainly the ones seeking to exit, including hedge funds and active investors, while institutional investors had been more stable.

Commodity indexes have been one route investors have used to access the asset class and commodity indexes have proliferated during the commodity price boom.

The more well-established commodity indexes are likely to benefit in current market conditions.

"Several banks will continue to make markets in indexes, 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 indexes.

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.

PLAIN AND SIMPLE

In Europe, investors have also gained access to commodities via structured investment products.