Strategic and Tactical Allocation to Commodities for Retirement Savings Schemes

Abstract

We examine whether the variance risk of investment portfolios of pension schemes investing in traditional asset classes can be reduced by extending the set of traditional investment opportunities with commodities. We investigate the economic and statistical significance of shifts in the strategic (three year), myopic (quarterly), and tactical (quarterly rebalancing) mean-variance frontier for pension schemes with a fixed liability portfolio. We find substantial differences in optimal strategic allocations for pension schemes with nominal and inflation-indexed pensions. While our results suggest that commodities reduce the risk on the funding ratio from an inflation-indexed scheme more than 30 percent, the optimal expected return and risk trade-off is unaffected for pension schemes with nominal claims. Similar results are obtained for the unconditional myopic investor with a quarterly investment horizon. When conditioning information about the macro economic situation is used, a pension scheme with nominal claims can during certain periods also improve its efficient risk-return trade-off by investing in commodities. Moreover, we investigate the use of quarterly timing strategies switching between commodities and stocks, in addition to the buy-and-hold investments in the traditional assets and commodities. Both for nominal and real pension schemes, timing strategies can be useful in addition to the strategic allocation. The liability hedging property of commodities is likely to reduce the probability of underfunding.

Keywords: Asset Liability Management, Commodities, Optimal portfolio choice, Pension funds, Strategic asset allocation, Tactical asset allocation

JEL Classification: G11, G18, G23