CalPERS’ New Investment Chief Sees a Future in Commodities

The financial wizard hired to invest billions of dollars for the state pension system is about to take the nation’s largest pension fund where it’s never gone before: into commodities.

Commodities are raw materials such as oil, metals and grains traded on the open market in the form of securities such as futures contracts. They are considered risky, but in recent years they have often paid off handsomely.

Undeterred is Russell Read, who is taking over investments for the $208-billion California Public Employees’ Retirement System. He thinks the risks are worth the potential payoff.

“We believe commodities are an important asset class that is likely to represent a core investment for our fund,” Read said, choosing his words carefully during an interview in CalPERS’ new $265-million headquarters building.

Read, 43, took over management of CalPERS’ portfolio this summer, at a time when questions are being raised about the fund’s ability to meet its ongoing -- and growing -- responsibility for paying retirement and healthcare benefits for 1.4 million active workers and retirees and their families.

The new chief investment officer said he expected to begin putting his strategy in place at a September workshop on commodities trading with CalPERS’ 13-member board.

If the board approves, the fund could make its first commodities buys as early as October. He declined to predict how much money CalPERS might invest, but it is expected to be only a small share of the state’s vast portfolio.

Read predicted that prices for items such as oil, copper and soybeans should stay strong, fueled by high demand from the fast-growing economies of China, India and other so-called emerging markets.

“The world is not currently positioned to provide for the energy and raw material needs of those economies” at the same time that it meets consumption by industrialized countries, Read said.

For years, the state has relied substantially on passive investing in broad-based domestic stock indexes. But those kinds of investments no longer guarantee the growth that CalPERS needs to hit earnings targets.

If CalPERS’ investments fall short, the state is obligated to dip into the treasury to cover billions of dollars in retirement benefits promised to government workers.

What’s more, traditional index investing could provide lackluster returns if the U.S. stock market flattens for a lengthy period, as it did between 1964 and 1980, Read warned.

CalPERS estimates that it will need to earn an average of at least 7.75% a year for well into the future to meet obligations.

Some market watchers say CalPERS’ estimate is too rosy and that it is far-fetched to think that it can earn a steady 7.75% a year -- much less the 9.2% average annual return the fund has made in the last decade.

Others disagree, saying that the 7.75% is a reasonable expectation given CalPERS’ size and diversified portfolio.

Boosting earnings by trading commodities and other exotic instruments should be relatively safe for a fund as big as CalPERS, say pension and investment analysts.

“I don’t think investments in commodities raises any more alarms than CalPERS’ investments in the past,” said Mercer Bullard, a securities-law professor at the University of Mississippi.

Commodities are a prudent investment for CalPERS as long as managers don’t “overweight it or overdo it,” said economist Sung Won Sohn, chief executive of Los Angeles-based Hanmi Financial Corp. “It’s hard for me to see commodity prices rising at the rate that they have” if worldwide demand begins to slacken.

But buying and selling corn futures, nickel or natural gas is just part of Read’s plan for continuing CalPERS’ recent winning streak of earning double-digit returns for the last three years. CalPERS posted an impressive 12.3% rate of return for the fiscal year ended June 30.

Read, who was the highly regarded deputy chief investment officer at Deustche Asset Management in New York before his CalPERS assignment, wants to combine futures plays with targeted private equity investments in companies that exploit and sell commodities.

“The biggest story, I believe, is not in the commodities themselves,” he said. “But, rather, the biggest opportunities will lie in the capital markets for the companies that earn enormous profits by introducing new technologies for producing and distributing commodities.”

The oil industry, which is enjoying record profits, is a clear example of money to be made in energy, Read said.

New areas of investments, he said, could include ethanol plants that produce alternative fuels for motor vehicles and intermodal railroad systems.

“We anticipate that the nature in which we do shipping and the nature in which utilities produce energy is likely to be dramatically different,” he said.

Companies that concentrate in energy and raw materials could account for as much as half of initial public offerings “over the coming decade,” Read predicted.

Investments in commodities could act as important hedges to “lock in profits” at companies that process such raw materials, Read suggested. For example, buying corn futures at a good price could ensure good margins at an ethanol plant where CalPERS has a stake, he said.

But timing is everything in investing, and Hanmi’s Sohn said CalPERS already could be a bit late. “I’m not sure if I’d be too aggressive. The way I see it, to some extent the bloom is off the rose in areas such as energy,” he said.

“I think we’ve probably seen the peak in energy prices, especially if we expect an economic slowdown in China.”