The strategy has worked - if you gauge success solely by the rising returns that come from a market where oil prices have doubled in the last year to levels above $130 a barrel and other commodities are also sharply higher.
But this story has an ironic twist: The money put into commodities is boosting the inflation investors have been trying to offset.
This isn't meant to lay blame for the rise in oil prices entirely on these investors' shoulders. They are part of the problem, along with soaring demand for oil in developing nations like China and India while global supply remains tight.
In recent weeks, however, more attention has been drawn to the big money these investors are putting into commodity-index funds. They don't actually own any of the commodities. Instead, they trade futures contracts, which are agreements that oblige the investor to buy or sell an asset at a predetermined price. Futures are considered a benchmark for prices in the market.
Critics allege that the continual inflow of institutional money is hijacking the market because the indices are permitted to bypass traditional speculative position limits imposed by the Commodity Futures Trading Commission.
"The rise in price of oil has weakened demand for the physical commodity, but it has boosted demand for the financial commodity since more investors are chasing returns," said Jeffrey Kleintop, chief market strategist at LPL Financial.
In the last five years, investment in index funds tied to commodities has grown from $13 billion to $260 billion, and the price of the 25 commodities that compose those indices have jumped 183 percent, according to congressional testimony from Michael Masters, managing member of the Virgin Islands-based hedge fund Masters Capital Management.
Masters dubs the pension and other investors as "index speculators." He estimates that in the first 52 trading days of this year, they flooded the market with $55 billion - in a self-fulfilling prophecy of sorts since the more money they put in, the more prices rise.
Research from Lehman Brothers supports that view. Performance of commodity indices can strongly predict inflows to those indices, which suggests there is a "significant amount of momentum chasing" going on, Lehman's chief energy economist Edward Morse said. Inflows are also higher when traditional asset classes like equities underperform or the dollar is weak.
Masters cites data showing annual Chinese demand for petroleum, based on government figures, has increased over the last five years by 920 million barrels; over the same time frame, the increase in demand for petroleum futures almost equals that at 848 million barrels.
"Individually, these participants are not acting with malicious intent," Masters said in his May 20 testimony. "Collectively, however, their impact reaches into the wallets of every American consumer."
Not everyone sees things Masters' way. Jeffrey Harris, chief economist at the CFTC, which regulates commodity markets, countered Masters' attack by telling lawmakers that "fundamental economic forces and the laws of supply and demand" are pushing prices higher, not fund positions.
Yet on Thursday, the CFTC announced it was six months into a wide-ranging investigation of U.S. oil markets, with a focus on possible price manipulation. It also announced a push to increase transparency of U.S. and international energy futures markets.
For instance, the CFTC said it will immediately require monthly reports from institutional investors who manage funds, which will help regulators identify the amount of such index trading and to "ensure that this type of trading activity is not adversely impacting the price discovery process."
The California Public Employees' Retirement System, the nation's largest public pension fund, is among those investors moving into commodities. It increased exposure to commodities beginning early last year as a way to diversify its portfolio. Such investments are now valued at $1.1 billion of its nearly $247 billion in total investments.
"In our book, it is not what we call speculation," said CalPERS spokesman Clark McKinley. "We took a long time to get into this market and we have a long time frame in our investment window left," which McKinley says runs 10 to 12 years.
There are, however, some unintended consequences from this investment strategy; it's driving prices up. That puts further strain on an already weak economy, as consumers and businesses face higher costs for gas and food.
The effect is already being felt by corporate America and that's bad for the stock market - where most of these investors put most of their money.
Drives up prices. Weakens the economy. Puts pressure on stocks. Not much of a hedge, is it?
