The role of gold

Raquel Pichardo-Allison: What role does gold play within a pension funds’ portfolio?

Anthony Rochte: For a pension fund, much as it would for any long-term investor, gold can be used for both tactical and strategic investment reasons. The most widely cited reasons given by investors for gold buying are threefold: gold’s dollar hedge properties, its ability to provide protection from possible future inflation, as well as a source of diversification in their portfolios.

Portfolios that contain even a small allocation of gold are proven to be generally more robust and better able to cope with market uncertainties than those that do not, showing improved stability and predictability of returns. 

The reasons for this are to be found in gold’s supply and demand fundamentals. The geographical and sectoral diversity of gold demand insulates gold from the negative effects of low points in the economic cycle. As a result, gold’s correlation to most other assets is exceptionally low. This independence is proven to hold across geographies, markets and time.

Raquel Pichardo-Allison: Have pension funds been open to investing in gold?

Anthony Rochte: Historically, most pension fund exposure to gold has come indirectly via a broad commodity vehicle. However, interest in gold as a stand-alone vehicle has been increasing recently as schemes grapple with striking the right risk/return balance in their asset allocation. In the US, several pension funds have recently realised the positive benefit of an investment in gold and have added an exposure to it. 

Raquel Pichardo-Allison: Why would pension funds invest in gold instead of other commodities? 

Anthony Rochte: While gold certainly has a place in a basket of commodities, it also differs substantially from other commodities, with additional benefits, and is therefore also entirely valid as a stand-alone investment. When most commodity prices fell in tandem with oil during the financial crisis, gold did not respond in the same way. 

The relationship between gold and the rest of the commodity complex is not as close as one might think. Most commodity consumption is heavily linked to industrial usage, meaning that commodities tend to fare badly in uncertain economic times when industrial demand and consumer confidence are eroded. Historical analysis shows that the vast majority of gold demand reflects discretionary spending meaning that it is less exposed to the vagaries of the economic cycle. 

Raquel Pichardo-Allison: What are some questions pension funds should be asking before they invest in gold?

Anthony Rochte: Questions pension funds should consider before investing in gold include: Am I looking for short-term, tactical investments or longer-term ways to balance risk and make my portfolio more robust? What does gold do to the performance of my overall portfolio? Do I want a physical asset or simply exposure to the gold price? Will I want the gold delivered or vaulted? What are the associated costs? Is the counterparty reliable and trustworthy? 

Raquel Pichardo-Allison: How can pension fund managers incorporate gold into their portfolios? 

Anthony Rochte: There is a wide range of methods available to investors wanting to buy gold, or gain exposure to gold price movements. They include gold exchange traded products, accounts, certificates, orientated funds, structured products (forwards), bars and coins and mining companies. In practice, however, ETFs are probably the vehicles most appropriate to institutional investors seeking simple and direct exposure to gold.

Raquel Pichardo-Allison: How has gold performed over the past three to five years when compared to more traditional equities and fixed income?

Anthony Rochte: Gold has performed strongly compared to other investments, with gains of approximately 20% annually over the past five years. Equities have struggled over this time period, largely due to 2008 declines. Fixed income has delivered positive single digit returns. Broader-based commodity indexes have had negative performance over the past three years.

Furthermore when it comes to volatility, gold tends to vary less than benchmark equity indices in the UK and abroad. During 2009, gold posted an annualised volatility of less than 23%, lower than the FTSE 100, MSCI Europe (excluding UK) and MSCI US indices. It was also 30% less volatile than the S&P Goldman Sachs Commodity Index during the same period. 

Raquel Pichardo-Allison: Gold prices have recently had a strong run. Should investors be concerned that gold is overvalued? 

Anthony Rochte: The gold price has actually been building steadily for nine consecutive years, reaching US$1115.25/oz on the London PM fix on February 16, 2009. Arrival at the current trading range of $1,000 to $1,200 has been a measured rise, supported by a combination of favourable gold fundamentals, which remain strong. 

Raquel Pichardo-Allison: What will happen to gold once markets stabilise? Is this something pension funds need to worry about? 

Anthony Rochte: It is true that some low volume rallies in equity markets occurred in 2009, but the price of gold remained resilient. Gold’s fundamentals remain strong and are forecast to remain so. The unique sectoral and geographical diversity of gold’s price drivers are a luxury many other commodities don’t enjoy. Longer term investors can gain some comfort from gold’s independence from broader market movements and their relative stability or otherwise.

Raquel Pichardo-Allison: Late last year, the Teacher Retirement System of Texas launched its maiden internally managed gold fund. Can we expect to see more pension funds developing internal capabilities to invest in gold? 

Anthony Rochte: As more pension funds consider gold as a distinct asset class, we could certainly see these funds continue to extend their internal capabilities, but this does not preclude them taking advantage of existing gold-based investment vehicles, for example the SPDR Gold Shares (GLD) exchange traded product.