The investment in commodities using derivatives such as total return swaps and futures means the fund has to keep a cash position in order to prevent leverage. This cash position has to be equal in size to the total commodities exposure of the derivatives. On a monthly basis PGGM’s positions are rebalanced to ensure this.
Although commodities swaps and futures are denominated in US dollars, the cash positions are held in euros, but in the monthly rebalancing the position is also adjusted for the euro-US dollar exchange rate, following the decision to hedge foreign exchange risk 100%, in line with the ALM study finding. Consequently, the foreign exchange risk is limited to the mark to market of the derivatives as this develops through the month. This is no different to a currency hedge that is adjusted monthly. By having both the leverage reset and the currency risk reset at the same moment, PGGM saves on the number of hedge transactions.
“We were faced with the problem that we now have much more cash than the pension fund would normally hold on a long term basis, normally our liquidity is a result of the investment process,” says Piet Roelandt, senior investment manager. Having a sizeable amount of cash (e2bn) to invest created a number of problems for the fund.
Before the commodities programme, PGGM just held small cash positions for liquidity purposes only, and was managed by using short-term deposits with a limited number of banks. Deposits are not necessarily the best instruments to invest in both from a return and liquidity perspectives. Placing such a sum with a limited number of counterparties, would concentrate the credit risk and would use existing credit lines. “Also, we would not be taking advantage of the broadening of the money market, since the introduction of the euro,” he says.
But also banks no longer welcome deposits as in the past, Roelandt points out. “Disintermediation is a trend we are faced with.”
“Since the back office systems were not capable of administering all available products, we wanted to use a fund structure.”
A fund structure would certainly facilitate administration. And it would also facilitate management along customised guidelines. These guidelines include minimum credit ratings and concentration limits, among others.
Roelandt says: “This gives us the best of both worlds, and has more liquidity than a deposit would necessarily have.” If cash is needed for the commodity swaps programme settlements, it is just a matter of disinvesting from the fund.
“As we are holding this cash on a long-term basis, we are hoping to generate additional returns, over and above the six-month Euribor benchmark of the fund.
“We decided to look externally for a manager with the required expertise. Citigroup Asset Management was selected from four potential managers.
“Our selection criteria included having money market fund expertise, particularly within the US marketplace, where the industry is more advanced in this area, but we also looked at their commitment to the euro markets.”

Roelandt says the fund looked at the investment process particularly in relation to new instruments, the operational systems and procedures, and the “strong credit risk management capabilities”.
What especially impressed PGGM was the ability of a dedicated fund structure. “Citigroup came up with this solution, independent of ourselves, as they had offered this to other institutions.” The initial investment could be increased in due course once the new fund is operating successfully. “We still do a certain amount in deposits and short term papers, as we build up expertise in this area.” The pension fund reckons that the euro money markets have developed and are now achieving the critical mass that the markets in the US have. Money market funds able to access these are going to attract increasing interest from institutions, Roelandt predicts.

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