Adding Commodities to Portfolio

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nickfrank
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Adding Commodities to Portfolio

Post by nickfrank »

We am considering adding a commodities fund to a portion of our stock allocation. I would like to keep our all Vanguard status. I see where Vang. has the Materials Index fund Admiral as an offering. Has this fund been discussed on the forum? What about Precious Metals and Mining? What are others here using?
Mill
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Re: ADDING COMMODITIES TO PORTFOLIO

Post by Mill »

I cant speak for the Materials Index fund. But the Prescious metals and Mining fund is a collection of mining stocks, so it wouldnt give you the type of commodities exposure you seem to be seeking.
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Rick Ferri
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Re: Adding Commodities to Portfolio

Post by Rick Ferri »

I agree that owning commodity producing companies is better than owning individual commodities or commodity futures. Companies have earnings, earnings growth and pay dividends. Commodities don't generate any income, don't grow, and are not going concerns. In fact, they cost you money to own and store.

The cost of slicing the stock market into thin pieces to gain more "risk" diversification has to be justified by a portfolio benefit. It's like slicing a pie. The more you slice, the more crumbs stick to the plate and the knife, and the less you have in aggregate. There has to be a real benefit from spending the money in the form of a higher risk-adjusted return.

I do treat REITs as a separate equity asset class because it has different underlying collateral, a different tax structure and tend to have different risks than common stocks. This isn't true about commodity companies. I also use a small value index fund as part of the allocation because it provides extra exposure to small cap and value risks, in accordance with the Fama-French Three Factor Model.

In summary. more often than not, what sounds like a good investment isn't a good investment. Investigate all corners of an idea before leaving crumbs on the plate.

Rick Ferri
Last edited by Rick Ferri on Wed Feb 06, 2013 11:41 am, edited 1 time in total.
The Education of an Index Investor: born in darkness, finds indexing enlightenment, overcomplicates everything, embraces simplicity.
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midareff
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Re: Adding Commodities to Portfolio

Post by midareff »

I use PCRIX in my taxable VG brokerage account. It deals in commodities futures secured (I believe) by holding short term governmental TIPS. It generally goes up/down when other things go the other way. I hold about 4% of total portfolio in it. Here's an interview wilth Larry Swedroe on commodities. I believe he cites PCRIX in his book.
http://www.hardassetsinvestor.com/inter ... ities.html
EDN
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Commodities in a Portfolio

Post by EDN »

I cannot find where adding commodities to a balanced portfolio has added any meaningful improvement. We have data on the DJ AIG Commodity index dating back to February 1991, so we can model the 3 Fund portfolio with and without it. We'll start with 42% Russell 3000, 18% MSCI All Country World exUS Index, and 40% Barclays Aggregate Bond Index as our "base", and 39% Russell 3000, 16% MSCI All Country World exUS Index, 35% Barclays Aggregate Bond Index, 10% DJ AIG Index as our "base with CCFs".

Through January of this year, the "base" earned 8.42% with an annualized SD of 9.16, the "base with CCFs" earned 8.28% with an annualized SD of 9.06, so really no difference. If you instead just swapped the Barclays Aggregate Bond Index with the Barclays Government Bond Index (same duration, no credit risk) in the 3 fund mix, you'd instead have earned 8.39% with an annual SD of 8.87.

In most cases, the simplest option is the best.

Incidentally, one of the issues with CCF indexes/funds is we're not even sure if they have a positive return in excess of the collateral. When you buy a CCF index, you get the return of the commodity futures and the return of the collateral (3mo t-bills). Since 1991, the DJ-AIG index has outperformed 3mo t-bills by 0.23% per month on average, but with 15 times the volatility. This means that our test for significance in excess returns is completely inconclusive, as the t-stat on the outperformance is only 0.9, well below the 2.0 we'd generally hope to see to say with some conviction that we are earning positive returns. Both US stocks and bonds, incidentally, have outperformed 3mo t-bills over this period with large positive t-stats (we are quite sure this is not a random outcome).

Eric
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Chan_va
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Re: Adding Commodities to Portfolio

Post by Chan_va »

I don't think commodities give you any diversification that the total stock market doesn't. (The exception being owning actual gold bullion as a catastrophe hedge. Asteroid impact for example.)

The only reason I am currently adding to the Precious metals and mining fund is that it is one of the few sectors that has done terribly over the past 3-4 years. If you buy the theory that you should buy on the dips, then this is a good time.
am
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Re: Adding Commodities to Portfolio

Post by am »

Does not seem like their is a good retail instrument to capture the potential returns CCF.

As far as Vanguard precious metals, this fund has had long periods of poor return, but when it goes up it really does. At some point 10k turned into about 50k over the last 10 years. Not sure how it fits into a portfolio?
Xanadu
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Re: Adding Commodities to Portfolio

Post by Xanadu »

Chan_va wrote:I don't think commodities give you any diversification that the total stock market doesn't. (The exception being owning actual gold bullion as a catastrophe hedge. Asteroid impact for example.)
If the asteroid is made of gold, this might have the opposite effect. :shock:
hazlitt777
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Re: Adding Commodities to Portfolio

Post by hazlitt777 »

My advice is not to bother adding commodities unless you actually take possession of gold bullion or at least purchase an ETF that actually holds gold separately allocated for you. (I say gold because it is the most simple and cost effective way to obtain exposure to commodities.)

Diversification is smart, even if some of what you invest in might not give you a return. Part of investing is making sure you have something to protect you in all economic situations which may arise.

And there doesn't have to be a catastrophe for gold to give you a nice nominal return. My gold bullion has done just fine for me over the past 10 years.
hafius500
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Re: Adding Commodities to Portfolio

Post by hafius500 »

Copied from another thread:

GMO on the diminishing diversification benefits and returns of commodities and TIPS:

GMO Letter 4 Q 2012, Inker - We Have Met The Enemy, and He Is Us
So, by the time we’ve got the institutions involved, we’ve taken an asset (long commodity futures) that had a long history of providing a decent risk premium over cash with low correlations to other investments and both increased its correlations with other asset classes and driven its long-term expected return down to the point where it may well be zero or negative ........
Our conclusions on TIPS are not as stark as with commodities – it looks like their historic returns relative to treasuries overestimate what they are likely to do going forward, but the process of “disappearing return premium” is not as far along. That being said, things seem to have started changing for TIPS, and we think investors should be aware of how the future of TIPS may be fairly substantially less exciting than their past has been.........
As we go forward from here, it seems perfectly plausible, although certainly not assured, that the breakeven rates will rise above market expectations of inflation, and TIPS will be priced to give a lower return than traditional treasury bonds....
TIPS and commodities have been lovely diversifiers historically, and this has led them to be included in more and more portfolios over time. Their effectiveness as diversifiers may well be less in the future and their returns quite likely to be lower....
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Wagnerjb
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Re: Commodities in a Portfolio

Post by Wagnerjb »

EDN wrote:Incidentally, one of the issues with CCF indexes/funds is we're not even sure if they have a positive return in excess of the collateral. When you buy a CCF index, you get the return of the commodity futures and the return of the collateral (3mo t-bills). Since 1991, the DJ-AIG index has outperformed 3mo t-bills by 0.23% per month on average, but with 15 times the volatility. This means that our test for significance in excess returns is completely inconclusive, as the t-stat on the outperformance is only 0.9, well below the 2.0 we'd generally hope to see to say with some conviction that we are earning positive returns. Both US stocks and bonds, incidentally, have outperformed 3mo t-bills over this period with large positive t-stats (we are quite sure this is not a random outcome).

Eric
Academic finance theory tells us that an asset class with negative correlation to equities (even mild negative correlation) will have poor returns, and this is due to the benefits realized by adding the asset class to a portfolio of stocks. We have an awful lot of data on commodity returns, and they exhibit these low returns and negative correlation. About a decade ago, a few papers were published stating that these collateralized commodity funds actually defied the laws of gravity - that is, they had positive stock-like returns PLUS the negative correlation that is so beneficial to a portfolio. These papers used artificially constructed returns from before CCF's existed. Well, it sure looks like real world data is proving them wrong. Not only are returns very weak, but the negative correlation didn't show up at all in 2009 - just when you needed it.

Just say no to expensive CCF's.

Best wishes.
Andy
hazlitt777
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Re: Commodities in a Portfolio

Post by hazlitt777 »

Wagnerjb wrote:
EDN wrote:Incidentally, one of the issues with CCF indexes/funds is we're not even sure if they have a positive return in excess of the collateral. When you buy a CCF index, you get the return of the commodity futures and the return of the collateral (3mo t-bills). Since 1991, the DJ-AIG index has outperformed 3mo t-bills by 0.23% per month on average, but with 15 times the volatility. This means that our test for significance in excess returns is completely inconclusive, as the t-stat on the outperformance is only 0.9, well below the 2.0 we'd generally hope to see to say with some conviction that we are earning positive returns. Both US stocks and bonds, incidentally, have outperformed 3mo t-bills over this period with large positive t-stats (we are quite sure this is not a random outcome).

Eric
Academic finance theory tells us that an asset class with negative correlation to equities (even mild negative correlation) will have poor returns, and this is due to the benefits realized by adding the asset class to a portfolio of stocks. We have an awful lot of data on commodity returns, and they exhibit these low returns and negative correlation. About a decade ago, a few papers were published stating that these collateralized commodity funds actually defied the laws of gravity - that is, they had positive stock-like returns PLUS the negative correlation that is so beneficial to a portfolio. These papers used artificially constructed returns from before CCF's existed. Well, it sure looks like real world data is proving them wrong. Not only are returns very weak, but the negative correlation didn't show up at all in 2009 - just when you needed it.

Just say no to expensive CCF's.

Best wishes.
The real world data I see at least for gold, seems to be different. In 1971 gold was around $35 an ounce. Now it is around $1657 an ounce.

Using this calculator, http://www.dinkytown.net/java/AnnualReturn.html

that is an annual return of 9.65%
EDN
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Does Gold Have a Real Return?

Post by EDN »

hazlitt777 wrote:
Wagnerjb wrote:
EDN wrote:Incidentally, one of the issues with CCF indexes/funds is we're not even sure if they have a positive return in excess of the collateral. When you buy a CCF index, you get the return of the commodity futures and the return of the collateral (3mo t-bills). Since 1991, the DJ-AIG index has outperformed 3mo t-bills by 0.23% per month on average, but with 15 times the volatility. This means that our test for significance in excess returns is completely inconclusive, as the t-stat on the outperformance is only 0.9, well below the 2.0 we'd generally hope to see to say with some conviction that we are earning positive returns. Both US stocks and bonds, incidentally, have outperformed 3mo t-bills over this period with large positive t-stats (we are quite sure this is not a random outcome).

Eric
Academic finance theory tells us that an asset class with negative correlation to equities (even mild negative correlation) will have poor returns, and this is due to the benefits realized by adding the asset class to a portfolio of stocks. We have an awful lot of data on commodity returns, and they exhibit these low returns and negative correlation. About a decade ago, a few papers were published stating that these collateralized commodity funds actually defied the laws of gravity - that is, they had positive stock-like returns PLUS the negative correlation that is so beneficial to a portfolio. These papers used artificially constructed returns from before CCF's existed. Well, it sure looks like real world data is proving them wrong. Not only are returns very weak, but the negative correlation didn't show up at all in 2009 - just when you needed it.

Just say no to expensive CCF's.

Best wishes.
The real world data I see at least for gold, seems to be different. In 1971 gold was around $35 an ounce. Now it is around $1657 an ounce.

Using this calculator, http://www.dinkytown.net/java/AnnualReturn.html

that is an annual return of 9.65%
Gold was illegal to own in 1971. If you are looking at Gold returns before 1975 (when it was legal to own), you are wasting your time IMO. Since 1975, Gold has had a 6% annualized return while CPI has been 4%. That might look economically significant, but with an annual standard deviation over 25, I can assure you that it does not have a statistically significant return above inflation (t-stat of about 1.0).

If it takes more than 40 years for an investment to produce a statistically significant real return, I'm OK taking a pass (especially when it has underperformed every other investment imaginable over this timeframe).

Eric
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SSSS
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Re: Does Gold Have a Real Return?

Post by SSSS »

EDN wrote:Gold was illegal to own in 1971.
Wasn't it legal to own foreign bullion coins such as Krugerrands?

And wasn't the law largely ignored anyway?
rj49
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Re: Adding Commodities to Portfolio

Post by rj49 »

am wrote:Does not seem like their is a good retail instrument to capture the potential returns CCF.

As far as Vanguard precious metals, this fund has had long periods of poor return, but when it goes up it really does. At some point 10k turned into about 50k over the last 10 years. Not sure how it fits into a portfolio?

You can get a little bit of commodities futures in the Managed Payout Funds, along with REITs, but they also have a Market Neutral Fund, with a very mixed history. Some have considered putting it in a retirement account and reinvesting the distributions.
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