Pension cash invested in commodity indexes rallies oil price

Pension funds are increasingly investing in commodity indexes to diversify their portfolios, according to a recent Lehman Brothers report.

The bank expects $25 billion to be invested in commodity indexes, such as the Lehman Brothers Commodity Index and the Goldman Sachs Commodity Index, during 2007. This passive investing has had the effect of rallying the price of crude oil by 7% since lows in mid-January, the report claimed.

However, Andy Green, European director of consulting at Mercer Investment Consulting, commented: “Given current market conditions, passive investment in commodity futures may not be as beneficial as investing directly in energy and mining shares, or in actively managed strategies.” He added that since the market is in contango, where longer-dated futures contracts trade at a premium to the spot price, more traditional commodity futures-based index strategies' returns were reduced. This is due to the so-called negative roll yield that occurs when passive index investors sell an expiring front month contract and buy the subsequent month contract.