While Commodities Encounter Ethical Scrutiny, Others Assert Social Stigma Is Political, Press-Driven

(June 22, 2011) — Following huge inflows into the commodities sector that critics claim have driven inflation while hurting poor nations, pension funds and other institutional investors are beginning to rethink their investments in commodities from an ethical perspective.

One concern among institutional investors is that billions of dollars in new investment from pensions and hedge funds may contribute to high volatility. “The last thing they want to do is to be on the other side of a trade to a starving person in Africa,” a source in the fund management industry told Reuters, noting a heightened concern among investors about rising grain and fuel prices fueling a rise in poverty in developing countries.

However, some warn that fears over commodity investment and spiraling food prices are largely unwarranted, based on incomplete information. “Yes, pensions are beginning to question their investment in the sector, thinking it may be unethical to invest in commodities. But the fact that their investment is directly pushing up prices — namely making food commodities scarce and impacting less developed countries — is largely political and press-driven,” Shelley Goldberg, director of global resources and commodities strategy at Roubini Global Economics (RGE), told aiCIO when asked about the social effects of investments in commodities and the possible contribution to increased poverty.

“I’ve met with a number of portfolio managers, and I’ve found that what’s really needed is education as to the dynamics on why commodity prices are going up,” Goldberg said. “It’s not just institutional investment in commodities that’s driving up prices — it’s also increased use in biofuels which diverts food, such as corn, to fuel production, incentivizing farmers to grow corn instead of other crops. There’s also hoarding by governments to prevent domestic inflation, middle classes emerging in size and wealth demanding protein-based diets, along with the impact of the weak dollar and negative real interest rates driving commodity prices up, and the more volatile nature of weather patterns, among others. It’s not as simple and clear-cut as pointing to speculators.”

Goldberg noted that the current investing climate can be described as a period of “risk-off” across not only commodities but also other asset classes, spurred by uncertainty in the Middle East and North Africa (MENA) region and the potential for contagion as well as softening of emerging market economies and central banks tightening.

The expected departure away from commodities is also an idea embraced by Jeremy Grantham, chief investment strategist of fund manager GMO Capital Management, who wrote in a March newsletter that since growth of natural resources is severely limited as population and demand soar, the age of cheap commodities prices is over. “The world is using up its natural resources at an alarming rate, and this has caused a permanent shift in their value,” Grantham wrote in GMO’s latest quarterly newsletter. “We all need to adjust our behavior to this new environment. It would help if we did it quickly.”

According to Grantham, who is credited with warning of the economic downturn in February 2006 when he told Barron’s Magazine that “housing is a classic bubble,” long-term investors must alter their frame of reference to adapt to a rapidly changing world in which shortages will be common. He wrote: “If I am right, we are now entering a period in which, like it or not, we must finally follow President Carter’s advice to develop a thoughtful energy policy and give up our carefree and careless ways with resources. The quicker we do this, the lower the cost will be. Any improvement at all in lifestyle for our grandchildren will take much more thoughtful behavior from political leaders and more restraint from everyone. Rapid growth is not ours by divine right; it is not even mathematically possible over a sustained period…Because we have way overstepped sustainable levels, the greatest challenge will be in redesigning lifestyles to emphasize quality of life while quantitatively reducing our demand levels.”

Yet, despite the pessimistic view on commodities, the sector has gained ground among institutional investors as of late. According to a recent report by Barclays Capital, net inflows to commodity-related investment are expected to remain strong in 2011, driven largely by institutional investor demand. “The return of the institutional investor, massive inflows into precious metals led by the desire to hedge against financial market risk, and the gradual shift towards active management of commodity strategies were among the key stories of the year,” the Barclays report said.

In April, for example, in an effort to expand its staff of internal managers, Harvard University hired Satu Parikh to head its investment management team as managing director and head of commodities. Parikh’s move to Harvard Management signaled efforts by many institutional investors to increase their commodities exposure in an effort to achieve further diversification and hedge against inflation.