(Reuters) - Nearly five years after it began investing in commodities, the biggest public pension fund in the United States has yet to make any money in the asset class -- highlighting the difficulty even the largest and most sophisticated institutions encounter in wringing returns from investments in agriculture, metals and energy derivatives.

The California Public Employees' Retirement System (CalPERS) had assets valued at $236 billion at the end of March 2012, including $3.6 billion linked to commodity prices, according to the latest quarterly performance report presented to CalPERS investment committee in May.

The system began investing in commodities in October 2007. CalPERS' performance matters because it has been one of the highest-profile institutions to allocate significant funds to the asset class, helping make it more acceptable among traditionally conservative pension funds.

A review of the programme by pension consultants Wilshire Associates in May 2011 noted that the leading investment banks dealing with CalPERS, which included JPMorgan, Societe General, Barclays and UBS, "realise the benefit of having a visible plan sponsor like CalPERS being an active proponent of commodity investment."

But a careful analysis of the programme's performance suggests it has actually lost money. Between October 2007 and June 2011, the programme had a negative rate of return of 6.9 percent per year. Between July 2011 and April 2012, the fund achieved a positive return of just 0.1 percent, according to performance reports published on CalPERS' website.

And:

Overall, though, Wilshire rated the programme favourably.

CalPERS utilises a mixed approach which is in line with the current best practice being recommended to pension funds. Approximately 75 percent of the commodity exposure is indexed to the GSCI Total Return Index while the remainder is devoted to active (alpha-generating) strategies.

Wilshire explained "the majority of commodity exposure is done through inexpensive index swaps. Active strategies are then employed as opportunities are present in the market which are implemented via a swap on a custom index that reflects the positions CalPERS desires".

Praising the expertise available in-house, even if it is stretched thinly, Wilshire concluded "the portfolio manager has experience in a variety of commodity markets from prior employment and displayed an understanding of how experienced traders and portfolio managers can add value by exploiting inefficiencies in particular markets."

"Overweighting of commodity sectors which display positive attributes such as positive or less negative roll yield and avoiding those whose value gradually declines as the futures contract ages are at the heart of the commodity programme's active strategies." In o ther words, CalPERS seeks to avoid contango markets and look for backwardations.

David Fuller's view Every commodity supercycle entices pension funds and other money management groups into these markets. It was no different in the 1970s, although the weight of money directed towards commodities was certainly smaller than what we have seen on occasion over the last decade.

A good trader can succeed in most markets (the alpha portion mentioned above) and there have been a handful of reasonably successful commodity funds over the decades. They have tended to be small and therefore flexible. A number of hedged funds have also dabbled in commodities with mixed success.

A potentially big participant such as CalPERS was all but certain to fail, not least because it would inevitably wish to be a buy-and-hold investor, tracking the Goldman Sachs Commodities Index (GSCI) or some other commodity index. That would ensure an overweight in petroleum futures, which might seem like a good idea in a period of economic expansion, were it not for the fact that futures normally trade at contangos. Moreover, the presence of big and largely passive investors in commodity trackers can only bid up the contangos, ensuring rollover losses as these contracts move towards expiry.

You can see the problems with this weekly 5-year chart of the United States Oil Fund (USO), which is a WTI contract tracker. Unlike WTI crude, it has gone nowhere since its 1Q 2009 low. When I add a WTI overlay to the USO chart you can see the ravages of the contango, exacerbated by the temporary fashion for an oil tracker.

You can also see that these charts had a near perfect match during the surge to a peak in 2008 and subsequent crash. This was due to a temporary backwardation for WTI on the way up and fewer participants in USO. Also, the tracker will certainly fall in line with WTI but it will not participate in a gradual rise over time due to the large contango.

Similarly, this chart of the US Natural Gas Fund (UNG) - also a tracker, shown with an overlay of the natural gas 1st month continuation chart, provides further evidence of the contango problem for passive, buy-and-hold investors in commodities. In fact, you can clearly see that in any environment other than an occasional supply shortage resulting in a temporary backwardation, commodity futures funds offer far more shorting than buying opportunities.

Fullermoney has long maintained that commodity futures were never intended to be an asset class. They exist to facilitate commercial hedging by producers and consumers, and speculators grease the wheels by providing liquidity. The presence of large investors such as CalPERS, not to mention some of the big hedge funds, can distort thin commodity futures markets, disrupting the commercial hedging practices.

They can also aggravate commodity price inflation as we saw in 2008 and to a lesser extent in the last two years. This can have serious economic consequences ranging from exacerbating food shortages to triggering global recessions in response to oil price shocks. Central banks will often respond to a speculative surge in commodity prices by raising interest rates, slowing GDP growth in the process.

In my opinion, the only commodity funds that should be considered as investment vehicles are the bullion funds for precious metals. Investors increasingly regard gold, silver and to a lesser extent platinum as hard money currencies, with the attraction of being no one else's liability.