Commodities Funds: A Decade of Disaster

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Bill Bernstein
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Commodities Funds: A Decade of Disaster

Post by Bill Bernstein »

We now have a 10-year trailing return for the flagship commodities futures fund, PCRIX: 3.26%--just barely north of inflation.

One might argue that this is fine; since there was no inflation, the insurance policy didn't pay off.

In this case, that’s bogus: the driver for a commodities futures fund return is increasing commodities prices, which surely did occur; the price of just about any raw material you can touch doubled or tripled in the past decade. One wonders how these funds will do if commodities prices remain stable, let alone fall.

The investor who wanted to benefit from rising commodities prices would have been far, far better off with a strategy that simply invested in the stocks of the producing companies. VGENX, for example, did capture the rise in commodites prices at a 13.21% 10-year return.

And, remember, PCRIX is the pick of the litter.

The fallacy in the argument for  MCF's is that it was based on low short-term correlations with stocks and bonds. But that's not pertinent to real risk. Real risk is long-term returns shortfall, and these beasts seem to have that in spades.

Bill
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Re: Commodities Funds: A Decade of Disaster

Post by Kenkat »

So what exactly happened to PCRIX? It's not the TIPS that it invested in as the Vanguard Inflation Protected Securities fund returned around +4.8% over the same period. The only other thing I can think of is that the performance of the commodity futures that this fund invested in didn't match the performance of the commodities themselves. I don't know why that would be or if it will happen again or if the reverse might happen.

This asset class does seemed to have plunged into the trough of disillusionment.
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Re: Commodities Funds: A Decade of Disaster

Post by zaboomafoozarg »

kenschmidt wrote:So what exactly happened to PCRIX?
Well, the share price hasn't come close to recovering after the ~70% drop in 2008:

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Re: Commodities Funds: A Decade of Disaster

Post by Kenkat »

Interesting - the effect is tied to the 2008-09 crash. A quick internet search uncovered a more in-depth look:

http://media.mcclatchydc.com/smedia/200 ... ate.91.pdf

Crude oil (and commodities in general) fell 75% starting in July 2008 - as did this fund. What didn't happen is that while crude oil and other commodity prices recovered, this fund didn't. I feel like I should use the term contango or backwardation somewhere here but I am a bit of a bear with little brain and long words bother me...
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Re: Commodities Funds: A Decade of Disaster

Post by jeffyscott »

wbern wrote:The investor who wanted to benefit from rising commodities prices would have been far, far better off with a strategy that simply invested in the stocks of the producing companies. VGENX, for example, did capture the rise in commodites prices at a 13.21% 10-year return.
Vanguard's other commodity stock fund, VGPMX, has returns comparable to PCRIX, 3.07%. Still, even a 50/50 mix of the two would have returned over 8%.

My choice was to use T. Rowe's New Era fund for this purpose and it's 10 year return is 9.83%.
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Re: Commodities Funds: A Decade of Disaster

Post by Bill Bernstein »

What happened was:

A large pile of dumb money -----> Contango.

Jeffy: Good point; the precious metals producers were the worst of the lot, and they actually did a little worse than PCRIX (VGPMX not being a pure PME play) but the oil and base metals producers did very well.

To make another point, this is more than just a decade of bad returns for an asset class, which happens and is no big deal; it's that an entire class of vehicles has underperformed its underlying assets for a decade that gives off the unpleasant aroma.

Bill
Last edited by Bill Bernstein on Sat Dec 21, 2013 1:50 pm, edited 1 time in total.
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Re: Commodities Funds: A Decade of Disaster

Post by Rick Ferri »

Dr. Bernstein,

Commodities not a good investment over the past 10-years? I AM SHOCKED!!! :shock: You must be adding wrong.

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Re: Commodities Funds: A Decade of Disaster

Post by LadyGeek »

To decode the ticker symbols:

- Vanguard Precious Metals and Mining Inv VGPMX
- PIMCO Commodity Real Ret Strat Instl PCRIX

I used Morningstar so you can see the performance graphs and the associated benchmarks.
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Re: Commodities Funds: A Decade of Disaster

Post by baw703916 »

wbern wrote: Jeffy: Good point; the precious metals producers were the worst of the lot, and they actually did a little worse than PCRIX (VGPMX not being a pure PME play) but the oil and base metals producers did very well.
Bill, I enjoyed your columns on PME from your Efficient Frontier site a few years ago. Do you still feel the same way about this asset class (potentially a great diversifier IF one has quasi-infinite patience and tolerance for volatility)?

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Re: Commodities Funds: A Decade of Disaster

Post by Bill Bernstein »

Yes, and I feel a lot better about its prospects as a future diversifier today than I did 2 years ago.

The one thing I don't feel differently about is that, for the reasons you mentioned, it's an asset class that's appropriate for at most the one percent of investors with enough historical knowledge, patience, cash, and courage.

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Re: Commodities Funds: A Decade of Disaster

Post by magellan »

As I understand it, PCRIX tracks the Dow Jones-UBS commodity index. Over the past 10 years, the index seems to have dropped 6%.

For another data point, this pdf from Dow Jones indicates that the annualized total return over the last 10 years for the Dow Jones-UBS commodity index was 1.5% as of November 2013.

The difference between PCRIX's 3.4% and the index's 1.5% must be from gains on the TIPS collateral (minus the fund's ER).

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Re: Commodities Funds: A Decade of Disaster

Post by Browser »

Pretty much agrees with my finding that when you look at rolling time periods of 10 years and longer, adding commodities doesn't do much for your portfolio other than suck off total returns. Because of generally low correlations to stocks and bonds, can help reduce portfolio volatility and drawdowns during short term episodes, but even that doesn't always happen when it should -- witness the debacle in 2008. I think the view that commodities actually help long-term portfolio returns is finding fewer and fewer proponents these days.
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Re: Commodities Funds: A Decade of Disaster

Post by nisiprius »

It also fits the pattern of what you've called "Rekenthaler's rule: if the bozos know about it, it doesn’t work any more." I'm not quite sure when commodities started to be the flavor-of-the-month--we really need a handy term for a time period on the order of six months, since that actually seems like the rhythm of investing fashion, the time it takes for "everyone" to be talking about something.

At a rough indicators, when did Fidelity add commodities to its target-date Freedom funds? That would probably be a good marker for the moment at which you could say "the bozos know about it." Aug. 5, 2010: Target-Date Funds Embrace Commodities.

According to March, 2013, Consumer Reports Money Advisor, in 2006 Ibbotson Associates published an influential study apparently showing that commodities improved traditional portfolios. So, it takes about four years for it to be adopted by the bozos, and,
Worth the trouble?

...To see if Ibbotson's 2006 research would still hold up in recent years... We created two hypothetical portfolios that were worth $100,000 at the beginning of 2008. We invested one in an traditional mix of 60 percent stocks and 40 percent bonds. The other contains 51 percent stocks, 34 percent bonds, and 15 percent commodities, split evenly among three ETFs: the broad-based iShares S&P GSCI Commodity-Indexed ETF, SPDR Gold Shares, and iShares Global Timber and Forestry. During the past five years there was little discernible difference between the two portfolios; volatility wasn't reduced, nor were returns greater.
So, Fidelity adopted in in 2010, and since then, their own bond index fundd would have had higher return with MUCH less volatility than their commodity strategies fund:
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Re: Commodities Funds: A Decade of Disaster

Post by Bill Bernstein »

The DJ-USB index you're quoting is the *futures* index, which PCRIX has beaten by a few percent.

But the real comparison is with the *spot* index, i.e., the return of the underlying commodities.

I don't have the file in front of me, but since about 2006, the futures index has been flat, whereas the spot index has about doubled.

That gap is almost certainly due to big-time contango. I.e., the problem is with the futures index itself. As Larry has mentioned, it suffers from having predictable roll dates and is thus easy to front run. But as the PIMCO fund demonstrates, that predictability only a small part of the problem. The big problem, as Nisi points out, is the large volume of bozos.

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Re: Commodities Funds: A Decade of Disaster

Post by Browser »

I can personally testify to the bozo effect. Back when PCRIX was first issued, I thought it was a really good idea so I piled in. It did turn out to be a really good idea until the other bozos caught on. I got out when it started to peter out and I'm glad I did. The first Bozos got the cheese before the trap was set.
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Re: Commodities Funds: A Decade of Disaster

Post by LadyGeek »

I am confused. First, I see that Morningstar is using their own benchmark to track PCRIX PIMCO Commodity Real Ret and something called "Commodities Broad Basket" - neither of which PIMCO uses. Direct from PIMCO: PIMCO CommodityRealReturn Strategy Fund INSTL (PCRIX), it's the Dow Jones-UBS Commodity Total Return Index.

Going to the source, Dow Jones » Alternative Asset Class Indices has 4 variations for ETFs, 3 variations for ETNs. I don't own any commodities, so this is new to me.

In any case, why are you interested in a spot index? I thought that total return is what you are after, as the dividends are reinvested. If it was a stock fund, it seems like you are comparing a price index vs. total return index.
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Re: Commodities Funds: A Decade of Disaster

Post by Bradley »

Below is from M* on PCRIX

“ ...............the bulk of the fund's year-to-date underperformance came in May and June as real interest rates spiked across the yield curve on the heels of the Fed's announcement that it may start tapering quantitative easing earlier than anticipated. The fund's out-of-index bet on emerging-markets debt from Brazil, which has also suffered steep losses this year, further detracted from returns. The fund's 10.1% loss through Aug. 27 was roughly double that of the category average's 5.1% decline.”



If there is anything worse than a commodity fund it is an actively managed commodity fund.
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Re: Commodities Funds: A Decade of Disaster

Post by Bill Bernstein »

You care about the spot because that was the paradigm the whole strategy was based on: you'll benefit from increases in commodities prices that occur with inflation, and which correlate inversely with bonds and stocks.

Well, it turns out that's not true. And if the futures (the DJ-USB index everyone quotes) now, because of contango, don't actually benefit from commodities price increases, why own the things?

What this says is that you either want to own the commodites themselves (own the producing companies, put gold coins in the vault, store several thousand barrels of crude in your back yard) or be a *seller* of futures to the bozos.

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Re: Commodities Funds: A Decade of Disaster

Post by BradMajors »

Most of those who buy commodity futures do not do so with the expectation of making a profit. Why do you believe what they are doing is a "disaster"?
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Re: Commodities Funds: A Decade of Disaster

Post by abuss368 »

That is interesting. Thank you for the update.
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Re: Commodities Funds: A Decade of Disaster

Post by JohnDoh »

While one naturally hesitates to tangle with Dr. Bernstein and the other board heavyweights (all of whom I respect and admire), I think there is a lot of inaccuracy here.

As I see it there are three distinct issues:
1) is there a desirable asset class worth investing in in principle as part of a total portfolio;
2) if so, are there investment vehicles that make the asset class investable in practice; and,
3) if so and if so, has recent investing history altered negated (1) and/or (2).

---

1) The history of the CCF debate on this board is old and venerable and one can say that reasonable investors can and have and do differ. OTOH, one needs to be clear that the asset class in question is not "commodities" or "commodity spot prices". I don't have the various citations to hand, but the asset class in question is Collateralized Commodities FUTURES. Therefore the question has always been -- and remains today -- whether CCFs have desirable sources of return. One of those sources of return is "roll return" which MAY have been substantially altered by an influx investment money. (See #3 below). However, in principle CCFs can have positive returns REGARDLESS of the return in commodity spot prices. E.g. CCFs can have positive returns even if commodity prices are declining -- as long as the actual decline is less than the expected decline. Thus, one of the key characteristics of this asset class is its response to UNEXPECTED CHANGES IN COMMODITY PRICES and thus its response to supply and demand shocks. For CCFs: Supply shocks, good; demand shocks, bad. Within a total portfolio, these characteristics are deemed virtues by some and not-so-much by others.

2) Although front-running can be a problem, my understanding is that PCRIX in particular has taken steps to minimize that problem. In any case, the question is whether or not the net problem outweighs the net virtues of the asset class. For those not convinced by CCFs in principle, of course this is the death blow. For those who find virtue in CCFs, it's just another issue like high ER.

3) Perhaps there has been a bozo effect (although I am not convinced that the 10-year return demonstrates that). The problem of persistent contango (in oil particularly) due to investor sentiment is a real one, but my understanding is that even now CCF markets alternate between contango and backwardation. Am I wrong? In any case, if there is now a run out of CCFs, those who remain or enter will be in the same position as 10 years ago. (A kind of anti-bozo effect, if you will.)

---

Overall therefore I fail to see how the 10-year return to PCRIX, by itself, demonstrates anything. Much less so when it is compared to 10-year commodity spot prices and/or 10-year commodity company equity prices.

Full Disclosure: I have PCRIX at 7.5% of total portfolio.
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Re: Commodities Funds: A Decade of Disaster

Post by Bill Bernstein »

When the basic asset underlying a strategy doubles in price and the strategy itself is flat, that's a disaster. When these strategies started getting traction, the roll return was supposed to be a free lunch. Not one of the fund companies selling these funds ever warned, "you know, the roll return might destroy all of the vehicle's real return, even if the prices of oil, copper, and soybeans double."

Yes, I agree that 10-year returns, by themselves, prove nothing.

But when an entire class of mutual funds that is supposed to capture rises in commodities prices fails to do so for 10 years, something is very, very wrong.

Were tilted funds from DFA or Powershares to underperform their underlying universe by that much for that long, people would notice, and they'd be right to do so.

Bill
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Re: Commodities Funds: A Decade of Disaster

Post by beardsworth »

nisiprius wrote:"Rekenthaler's rule: if the bozos know about it, it doesn’t work any more." I'm not quite sure when commodities started to be the flavor-of-the-month--we really need a handy term for a time period on the order of six months, since that actually seems like the rhythm of investing fashion, the time it takes for "everyone" to be talking about something.
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Re: Commodities Funds: A Decade of Disaster

Post by LH »

PCRIX frontrunning always was a concern, felt like a nice juicy target, as well as the fact that its unclear that one can just put a ton of passive money in the market to buy commodities rolling, and not screw things up pricewise. though that is what we do in stocks, but my gestalt(weak) was that market impact was not felt via indexes, whereas in commodities, it could well be.

also, the construction of it, lots of moving parts. partly a TIPS investment.... then trying to get to the commodity via futures...... (frontrunning loops through thought process again), it was just never clear to me what it actually was/is in terms of PCRIX.

The whole PCRIX discussion though, led me to my purchase of gold DCA starting in february, almost up to my 3 percent near/medium term allocation. I keep hoping it really tanks, but it keeps hanging up there.

Swedroe gave a convincing argument, I thought, that even if an asset class (pcrix/commodities) has expected return is zero, if the correlation benefits are high enough, then it can be beneficial, for the portfolio.

I just never got a good gestalt for pcrix. I still do not really. I am still not convinced it may not do well in a high inflation, but I really have zero gestalt on it, just kinda a void of sorts. Its still on my list, with iREITS, ibonds, and pcrix.

Gold, looking at it sliding around the time period on a stock graph with all my asset classes, has tons of volatility, and tons of beneficial correlation relative to the rest of my portfolio (albeit neg return recently, but thats the point, something gotta suck, or you are not diversified, hurry up and plummet imo). A small amount, can jump up 4 times, drop 4 times, etc. Zig when everything else zags, in a big way.

I hope it Zags down. I want 5 percent minimum, and will likely go 10 percent, still mulling over it, if it dropped to 500 tomorrow, I would go to 10 percent most likely. Sit on it 20 years, see what if anything happens. Hopefully not much, let the other 90 percent of the portfolio kick butt, and gold just sit there : )

PCRIX, will be interesting to watch. I always think of maybe putting 2 percent of that in, 2 percent silver, 6 percent gold or something, for 10 percent commodities. But small slices of only 2 percent. Would have to have great volatility to make it meaningful (like silver), have to do things like double triple and such.

If inflation goes to 10 percent, PCRIX might be the new hottest thing. time will tell.
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Re: Commodities Funds: A Decade of Disaster

Post by stratton »

I've only been commodities and gold miners since 2008 after the crash. I took that as a signal to try it out. About 2.5% total between the two of them. I HAD 10% in REITS, MLP CEFs, gold miners and commodities.

I've made a ton of money on them, but have tax loss harvested out of VGPMX a month ago and rebalanced commodities up a little.

However, in the spirit of market timing I'm almost ready to abandon both. I've had a nice pile of money giving them haircuts on the rise up since late 2008 and just leaving now might be a great time to get out. :-)

I don't use the typical MLP CEF where the leverage acts as an attic to hold the future tax obligations. Mine is one of the two or three that are like a normal mutual fund and uses c-corp stock in place of MLPs to keep the partnership level below 25%.

Energy stocks being flat for a year look more "interesting."

Yes, this is part of the play money bin.

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Re: Commodities Funds: A Decade of Disaster

Post by Cb »

I gave up and sold this disastrous asset class a while back, but unfortunately, piled the proceeds into the toxic, hazardous waste asset class instead.
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Re: Commodities Funds: A Decade of Disaster

Post by shawcroft »

Thanks to all- and particularly Dr. Bernstein-for this very insightful series of posts. I recall hearing Dr. Bernstein mention "Rekenthaler's Rule" and his common sense explanation of it ("If the bozos know about it, its too late"). I have, on occasion, quoted this observation to folks in the financial services......who have not shared my amusement.
I've been told by a friend who lost quite a bit in a commodities deal some years ago that anytime his broker suggests commodities to him now, he sticks his head in a bucket of cold water until they stop talking. (Haven't quite got him to the land of Boglehead yet)
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Re: Commodities Funds: A Decade of Disaster

Post by Browser »

Dr. B is right. Most people invest in CCFs because they think they're investing in physical commodities which are going to behave is some understandable fashion based on the economics of physical commodities, and differently from equities and bonds. For example, if the price of oil rises by 50%, you figure you'll be holding some kind of hedge that will help offset that and possible consequent stock or bond losses. But they're really investing in a Rube Goldberg asset, "collateralized futures," which are going to dance to their own drummer. It's going to diversify a portfolio kinda like a guy on meth is going to diversify a social gathering, but you might not want to be a guest at that event.
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Re: Commodities Funds: A Decade of Disaster

Post by Kenkat »

Well, it seems that investing in commodity futures is not the same as investing in commodities themselves. I was/am fully aware that this fund invests in a commodities futures index; I thought less about situations where that wouldn't necessarily match the commodities themselves or whether that was good or bad. I do think that if commodity futures can, at times, do badly in relation to commodities themselves, then there are maybe - dare I say probably? - situations where they could do well in relation to the commodities themselves. Is there a future conversation where we say "look at PCRIX, it's up x% even though the commodities themselves are flat or down? Maybe.

I own a small chunk of PCRIX, have since 2003 and figure I'll just stick with it and out wait the bozos who will move on to the next big thing soon enough I'd imagine. My general experience is that hated asset classes aren't necessarily a bad thing (the "trough of disillusionment" effect*).

* The term comes from Gartner's Hype Cycle, which is an IT theory for the cycles that new technologies go through. I find it applies well to new things in general.
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Re: Commodities Funds: A Decade of Disaster

Post by magellan »

LadyGeek wrote:In any case, why are you interested in a spot index? I thought that total return is what you are after, as the dividends are reinvested. If it was a stock fund, it seems like you are comparing a price index vs. total return index.
I think Bill's point is that if the investor's intention is to simulate holding actual commodities, collateralized commodities futures funds are really just a means to an end. So looking at the performance of a CCF index doesn't tell you much about whether the strategy is meeting your ultimate goal of gaining exposure the risk factors you'd get if you held commodities directly. Of course, it's not easy to invest in the underlying commodities unless you plan on parking a big oil truck in your driveway, filling your basement with grain, and building a walk in freezer in your garage to store pork bellies and orange juice.

This makes Bill's standard seem a bit tough to me, especially considering we're talking about an alternative vehicle to get access to an otherwise tough to access risk factor. CCFs and actual commodities are not the same and it's expected that you could have large tracking errors, even over long periods of time as they react to various stimuli in different ways. I suppose it's not very different from the tracking error you could see when using a precious metals or energy stocks to simulate holding commodities. There's probably a similar tracking problem when comparing holding REITs versus owning and managing commercial real estate yourself.

In any case, my sense is that CCFs may offer some left-tail protection in some circumstances as long as investors stay the course. I've owned PCRIX almost since it opened and I'm generally satisfied that it will offer some help if we experience severe UNEXPECTED inflation, particularly if it's caused by a supply shock. So far, that hasn't happened much. In early 2008, when oil prices suddenly went crazy, PCRIX shot up like a rocket while stocks and even gold were flat. Later, when oil prices collapsed, PCRIX also collapsed. Its performance over this time was relatively reassuring to me. Like any alternative investment, I do worry about tracking error and high expenses and the drag on average returns. OTOH, I'm pretty confident that I am getting access to some additional risk factors with this investment and although it comes with a cost, I think including those extra risk factors in the portfolio could prove valuable under the right set of circumstances.

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Re: Commodities Funds: A Decade of Disaster

Post by Jack »

nisiprius wrote:we really need a handy term for a time period on the order of six months ...
Turns out there is one:
http://en.wikipedia.org/wiki/Friedman_Unit
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Re: Commodities Funds: A Decade of Disaster

Post by LadyGeek »

magellan - Thanks, that helped. I read Dr. Bernstein's reply and your explanation fills in the gaps. I guess that explains why I see a variety of different benchmarks tracking this fund - tracking error. Bear in mind I'm analyzing this like an engineer.

The wiki could also use some help to fill in the article: Commodities
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Re: Commodities Funds: A Decade of Disaster

Post by slowmoney »

Browser wrote:
adding commodities doesn't do much for your portfolio other than suck off total returns.
:oops:


Seems like people who "invest" in commodities have never spent a day on a government subsidized working farm. [OT comment removed by admin LadyGeek]
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Re: Commodities Funds: A Decade of Disaster

Post by shawcroft »

Jack wrote:Turns out there is one:
The Friedman Unit

Absolutely wonderful!
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Re: Commodities Funds: A Decade of Disaster

Post by staythecourse »

Dr. Bernstein,

Much respect to you, but it is not fair to blame CCF funds for not doing well when spot prices kept escalating at the same. All of these funds are CCF and are thus based on the futures market with returns based on: Spot+ roll return+ tbills (or TIPS). We already know looking at historically spot and tbills will, basically, follow inflation. The return then on CCF funds are COMPLETLEY based on roll return. If it is good then you get the HOLY GRAIL of investing (equity like returns, high volatility, and no correlation to stocks) and when they do bad you get 2000's.

Unless you feel increasing contango is from increased money into the space or frontrunning then can't see how blaming the CCF funds means anything. If I am investing in CCF and you told me there would be low inflation (especially no unexpected inflation in that period) I don't know how you would have expected any better returns then inflation?

Of course, one has not even talked about the use of CCF funds in the idea of most rationale investors who use them on this site: As subasset for the purposes of increasing portfolio diversification. Would be interesting to see Mr. Swedroe throw out some data on how a mix of assets with and without commodities did in the same time period.

Good luck.
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Re: Commodities Funds: A Decade of Disaster

Post by Bill Bernstein »

Staythecourse:

You're exactly right; the problem is with the roll return, which results from too much money chasing a very small opportunity set.

I don’t know how to “blame a fund,” but I do blame the fund companies who brought them out, likely knowing full well just what would happen. The people who run these funds are not dummies, and they must have known that throwing billions of dollars at futures would drive their prices up well into contango territory.

It’s certainly possible to make a mean-variance (diversification) argument for any asset class, but there comes a point that an asset's return can be so low that you don't want it in your portfolio no matter how low/negative the correlation is with the rest of your assets. A classic case are volatility futures, which have a strong negative correlation with stocks, but whose returns are so awful that they savage overall return and drive up portfolio volatility. Such is now the case with commodities futures, which likely have a negative expected return. (As you point out, return = commodities price + roll + collateral; if the roll continues to be negative several percent per year, that wipes out, in the long term, the other two terms, and then some.)

Will there come a point that so much money will flee these funds that normal backwardation (or at least a zero roll return) will result? It's possible, but I wouldn't want to bet on it. I’m willing to bet that as long as institutional players are the biggest buyers of commodities futures (and not just hedging producers like oil companies and farmers, which was the “normal” state of affairs described by Keynes) the roll return will continue, in general, to be negative.


Bill
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Re: Commodities Funds: A Decade of Disaster

Post by market timer »

wbern wrote:Will there come a point that so much money will flee these funds that normal backwardation (or at least a zero roll return) will result? It's possible, but I wouldn't want to bet on it.
Energy is the largest component of S&P GSCI, and it is now backwardated. Interestingly, you can buy Dec 2019 WTI futures for about $78/bbl, more than $20/bbl below the Feb 2014 contract.

WTI here: http://www.cmegroup.com/trading/energy/ ... crude.html
Brent here: http://www.cmegroup.com/trading/energy/ ... t-day.html
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Bill Bernstein
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Re: Commodities Funds: A Decade of Disaster

Post by Bill Bernstein »

Careful: what you're describing is not realized contango, but something else, what some call "trader's contango," the difference between the *current* spot and the current futures price.

But that's not what counts, which is realized contango: the difference between the *future* spot and the futures price.

The former is observable but irrelevant. The latter is relevant, unobservable before the fact, and what determines your return.

Bill
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Re: Commodities Funds: A Decade of Disaster

Post by Tonen »

These things were originally flogged to the market mainly on the basis of "normal backwardation"/positive roll return claims, with less mention of diversification/ inflation protection. Essentially, roll returns + the collateralised returns were supposed to give similar returns to that of equity markets, even if commodity spot returns were a wash. Historical evidence of these retrospectively constructed next-nearby long-only collateralised commodity futures purportedly showed there was a shortage of producers + speculators willing to provide the surety of future price that buyers wanted to lock in, hence buyers (on average) paid over the odds to lock those future prices in.
I invested in GSCI for a brief period via a Euronext commodities ETF around 2006 - brief as it seemed apparent even back then that contango on roll returns were becoming the norm due to a flood of hot money disturbing any previously existing market hedging relationships.
At least now the backwardation claims seem to have disappeared on the product blurbs.
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Re: Commodities Funds: A Decade of Disaster

Post by Bradley »

staythecourse wrote:Dr. Bernstein,

................ All of these funds are CCF and are thus based on the futures market with returns based on: Spot+ roll return+ tbills (or TIPS). We already know looking at historically spot and tbills will, basically, follow inflation. The return then on CCF funds are COMPLETLEY based on roll return.

COMPLETLEY based on roll return?

Every fund operates according to its own investment strategy. Each fund’s strategies are outlined in the fund’s prospectus. While some of the returns of these type of funds may be attributed to spot + roll + tbills ( or TIPS), PCRIX’s strategy uses timing based on its own forecast of future interest rates in addition to........... junk bonds, swap agreements, short sales, options on futures, preferred stock, leveraged derivative debt instruments(structured notes) and in a wholly owned "subsidiary" of the Fund organized under the laws of the Caymen Islands. This subsidiary may invest without limitation in commodity-linked swaps and other commodity-linked derivatives. The Fund and or the Subsidiary also attempts to time its allocations. The Fund is non-diversified, which means that it may invest its assets in a smaller number of issuers than a diversified fund. In addition, the Fund may invest its assets in particular sectors of the commodities market. Limits imposed by the prospectus include..........

10% of Fund’s total assets in junk bonds

30% of Fund’s total assets in securities denominated in foreign securities

10% of Fund’s total assets in emerging markets

10% of Fund’s total assets in preferred stock



These facts/risks may surprise some but they are clearly spelled out in the prospectus including the risk of investing in the Subsidiary.

Subsidiary Risk: the risk that, by investing in the Subsidiary, the Fund is indirectly exposed to the risks associated with the Subsidiary's investments. The Subsidiary is not registered under the 1940 Act and may not be subject to all the investor protections of the 1940 Act. There is no guarantee that the investment objective of the Subsidiary will be achieved


And this is the pick of the litter?
You can sum up any active fund manager’s presentation at an investor conference in one sentence: “We’re doing well, all things considered.”
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Re: Commodities Funds: A Decade of Disaster

Post by czeckers »

I've been thinking that since most commodity-linked investments (I.e. CCFs, precious metal mining funds, GLD) have had a pretty bad run over the last five years, now might be a good time to add a slice as a diversifier.

However, it hasn't been clear to me which vehicle would be the best choice. Thanks to Dr. Bernstein, I feel good about eliminating CCFs from consideration. GLD doesn't scream bargain yet. Vanguards precious metals mining fund is near all time lows which is attractive. It's being an actively managed fund gives me pause however. Also, GLD and CCFs are fairly new, and they only have one peak which could be attributed to the "bozos" who piled into the asset class when it became easy to invest in it thus making it unclear whether there is potential for a future peak in performance.

Thus, I stay the course without making changes for now.
The Espresso portfolio: | | 20% US TSM, 20% Small Value, 10% US REIT, 10% Dev Int'l, 10% EM, 10% Commodities, 20% Inter-term US Treas | | "A journey of a thousand miles begins with a single step."
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Re: Commodities Funds: A Decade of Disaster

Post by grayfox »

Isn't everyone missing the point of commodity futures funds? The question is, did CCF's do the job that they were designed to do, which was to make a ton of money for the fund companies?

I don't know, but PCRIX with expense ratio of 0.74% and $15.4 billion total assets, that works out to a whopping $113,960,000 in annual fees. :moneybag
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Re: Commodities Funds: A Decade of Disaster

Post by midareff »

and now you know the rest of the 20 mule team story.
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Re: Commodities Funds: A Decade of Disaster

Post by magellan »

I've been googling for some easy to assemble historical spot price data for the physical commodities in the Dow Jones-UBS commodity index to compare using a CCF strategy to holding physical commodities. So far no luck.

Dr. Bernstein's contention is that PCRIX did a lousy job tracking the price movements of the underlying physical commodities in the DJ-UBS index. He may be right, but I can't find hard data to show even the rough magnitude of the tracking error. My question is, had I been able to buy, hold, and rebalance all of the commodities in the DJ-UBS index, in the exact proportions that the index used, without trading or storage costs costs, what would my results have been compared to the DJ-UBS index?

Jim
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Re: Commodities Funds: A Decade of Disaster

Post by magellan »

Another (admittedly rough) way to evaluate the PCRIX 'disaster' is to compare the results of including PCRIX in a portfolio to the results of not including it. As you'd expect, this analysis is very dependent on start and end points.

This link has a morningstar 'growth of $10k' chart with PCRIX and some other tickers.

Growth of $10k over the last 10 years
- $22k - Vanguard Total Stock Market (VTSAX)
- $14k - PCRIX
That's an $8k loss per $10k invested in PCRIX. With a $1M portfolio with a 90%/10% allocation between VTSAX/PCRIX, the cost of holding PCRIX was $80k with a reduction in CAGR from 8.2% to 7.8%.

Growth of $10k since PCRIX inception
- $25k - Vanguard Total Stock Market (VTSAX)
- $22k - PCRIX
That's a $3k loss per $10k invested for holding PCRIX. So the cost of a 10% allocation to PCRIX was $30k with a reduction in CAGR from 8.7% to 8.6%.

Regardless of the starting and ending points, compared to any other alternative asset classes investors could have jumped into during this time, I'm not really seeing a disaster here.

My own strategy over this period was to combine a 5% allocation to PCRIX, 5% to GLD, and 5% to REITs in what I call a 'hard assets' category. I've been doing this since the late 90s (originally with physical gold, now with GLD). This allocation has actually improved my portfolio results over the decade compared to just allocating an extra 15% to stocks.

Growth of $10k over the last 10 years
- $22k - Vanguard Total Stock Market
- $14k - PCRIX (-$8k)
- $31k - GLD (+9k)
- $22k - REIT
With a $1M portfolio, a 85/5/5/5% allocation to VTSAX/PCRIX/GLD/REIT performed just a tad better than a 100% allocation to Vanguard Total Stock Index.

Growth of $10k since 2002
- $22k - Vanguard Total Stock Market
- $14k - PCRIX (-$3k)
- $31k - GLD (+25k)
- $22k - REIT (+$2k)
With a $1M portfolio, a 85/5/5/5% allocation to VTSAX/PCRIX/GLD/REIT resulted in an extra $24k $120k of return compared to a 100% allocation to Vanguard Total Stock Index.

Growth of $10k over last 5 yrs
- $24k - Vanguard Total Stock Market
- $16k - PCRIX (-$8k)
- $14k - GLD (-10k)
- $23k - REIT (-$2k)
With a $1M portfolio, a 85/5/5/5% allocation to VTSAX/PCRIX/GLD/REIT resulted in around a $70k $100k loss compared to a 100% allocation to VTSAX.

So over the past 10-15 years, this combination of PCRIX, GLD, and REITs has offered a costless insurance policy. Over the last 5 years, when stocks were on fire, the insurance policy cost me a couple dozen basis points.

Jim

(edited to fix a couple of calc. errors above - see crossouts)
Last edited by magellan on Sun Dec 22, 2013 12:20 pm, edited 1 time in total.
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Re: Commodities Funds: A Decade of Disaster

Post by BlueEars »

magellan wrote:....
So over the past 10-15 years, this combination of PCRIX, GLD, and REITs has offered a costless insurance policy. Over the last 5 years, when stocks were on fire, the insurance policy cost me a couple dozen basis points.
Jim, for most people here wouldn't it be more appropriate to compare a balanced portfolio with and without the special components?

Maybe a 60/40 compared to a 45/40/5/5/5, i.e. the PCRIX/GLD/REITs is taken from the equity side. Also it would be best to do this over several decades but I realize the data may not be all that robust going that far back. The Simba spreadsheet does have data for this.

P.S. I don't own any alternative asset classes. No axe to grind, just interested in the debate.
Last edited by BlueEars on Sun Dec 22, 2013 7:08 pm, edited 1 time in total.
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Re: Commodities Funds: A Decade of Disaster

Post by magellan »

BlueEars wrote:Jim, for most people here wouldn't it be more appropriate to compare a balanced portfolio with and without the special components?
That would be a truer comparison to reality, but since stocks outperformed bonds over all the periods we're considering, I figured using 100% stocks in the comparison would emphasize the cost of the insurance the most.

A few years ago, I did more detailed comparisons using Quicken and actual results and cash flows from my own portfolio over the 10 year period from 2000-2010. I discussed this a little in this post from the topic A tale of two woes, commodities and gold. Below is a spreadsheet graphic from that analysis:

Image

Jim
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Re: Commodities Funds: A Decade of Disaster

Post by Bradley »

magellan wrote:
Growth of $10k over the last 10 years
- $22k - Vanguard Total Stock Market (VTSAX)
- $14k - PCRIX
That's an $8k loss per $10k invested in PCRIX.


Growth of $10k since PCRIX inception
- $25k - Vanguard Total Stock Market (VTSAX)
- $22k - PCRIX
That's a $3k loss per $10k invested for holding PCRIX.

Jim,

I believe your data gives support to Bill's opinion that "A large pile of dumb money" is at the root of the under-performance of this product. Skating To Where The Puck Was includes a clear, well written explanation of why these funds should be avoided and should be read by anyone with an interest in this issue.
You can sum up any active fund manager’s presentation at an investor conference in one sentence: “We’re doing well, all things considered.”
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Re: Commodities Funds: A Decade of Disaster

Post by stlutz »

For the individual investor, I've never seen CCFs advocated as a serious (i.e. not completely speculative) investment choice anywhere else besides this board, which I do find a little disturbing.
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Re: Commodities Funds: A Decade of Disaster

Post by pop77 »

What would be a good fund or ETF that represents 'global commodity producers'? I am currently looking at GNR, are there any other comparable ones? Vanguard's funds seem to be either Energy or Precious Metals centric, that too within US. Fidelity recently introduced some sector specific ETF's but they are all US centric.
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