How Commodities Can Help a Portfolio

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
afan
Posts: 8191
Joined: Sun Jul 25, 2010 4:01 pm

Re: How Commodities Can Help a Portfolio

Post by afan »

Again, I am sure you pay far more attention to the holdings of PCRIX than I do. But their list of investments does not seem to imply that the commodities are simply long the UBS index.

http://investments.pimco.com/Shareholde ... %20731.xls

One can use the GSCI as an investable index to estimate returns to commodities. One would have to make some assumptions about costs, but the performance tells us what the commodities market did. To recommend commodities and expect to do better, one has to assume that active management will consistently beat the GSCI performance.

If I plot GSCI vs PCRIX over what Morningstar identifies as "maximum" it shows lower performance, but perhaps lower volatility, for PCRIX. So it again appears that PCRIX outperformed its target index, but not the commodities market. This is including the active management and the bond returns. If the bond returns are positive, then it would appears that the active management did not lead to it beating the commodities market. Of course, not having seen the disaggregated returns, I am only speculating here.

If I add VTI to the plot, then it looks like there was a period in 2006 to 2008 when VTI diverge substantially from GSCI and PCRIX. After that the commodities funds appear to have lower returns, more volatility, but quite similar return patterns. This would imply a substantial correlation. Again, I don't have the numbers, but it is hard to see a diversification benefit here.

If the rationale for commodities investing is that the commodities market has a low or negative correlation with stocks and bonds, then this applies to the commodities MARKET. To conclude that one should get commodities exposure by investing in a FUND that does not track the commodities market, then one would need to establish that this fund had the same covariance properties as the commodities market. If it is an active fund, one would also need to presume that the characteristics of the target index and the fund would not change going forward.

Without the kind of data that we have for stock index funds, adding the commodities market, or this particular fund seems to require quite a lot of assumptions that things will turn out as hoped.

But as I said, I find this more interesting than having practical implications for me. I will wait until there are more data to consider jumping in.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama
afan
Posts: 8191
Joined: Sun Jul 25, 2010 4:01 pm

Re: How Commodities Can Help a Portfolio

Post by afan »

If one wanted to hedge stock and bond risk, why not use derivatives to do this explicitly, rather than invest in a commodities fund and hope it pays off?
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

Re: How Commodities Can Help a Portfolio

Post by larryswedroe »

Afan
Unless something has changed recently, and I doubt it, as I said there is no commodity active management in the sense of having 100% exposure to the commodities in the ratio they are in the index. In fact for much of the trading is done in swaps, not futures, and the swaps pay the return of the index.
The active management is in the choice of roll dates and collateral, that's it.
so you are getting the exposure to the commodities exactly as you desire, just more intelligent approach to accessing that exposure, at least IMO, and it's also based on research
You seem to be seeking a ghost that isn't there.
I would just add that the active collateral management and months of rolling can lead to large tracking error--which is I guess what you are seeing
Larry
Bradley
Posts: 486
Joined: Tue May 01, 2007 2:41 pm

Re: How Commodities Can Help a Portfolio

Post by Bradley »

What do the thinkers at Dimensional think about adding commodities to a portfolio? “It’s nuts”, says the former head Director of investment strategy and current Board member and consultant to DFA’s investment strategies. If anyone understands objective financial research it is Kenneth French. Kenneth R. French is the Roth Family Distinguished Professor of Finance at the Tuck School of Business at Dartmouth College. He is an expert on the behavior of security prices and investment strategies.
French is a research associate at the National Bureau of Economic Research, an advisory editor of the Journal of Financial Economics, a former associate editor of the Journal of Finance and the Review of Financial Studies, and a former president of the American Finance Association. French is also a Fellow of the American Finance Association. Before joining Dartmouth, Professor French was on the faculty of MIT's Sloan School of Management, the Yale School of Management, and the University of Chicago Booth School of Business. Professor French received his PhD in finance from the University of Rochester in 1983. He also earned an MS and an MBA from the University of Rochester and a BS from Lehigh University.

Add to his opinions, those of Bogle, Bernstein, Ferri and Fama and I would conclude “Case closed”, “The fat lady has sung”, “game set match”..........etc. When you get what could be considered a “Dream Team” of experienced, credible investment professionals all singing the same tune it is safe to conclude commodities are not worth the time, expense or effort.



Q&A: What Role for Commodities?
There seems to be some confusion about your opinion on the role of commodities in a portfolio, based on a conference presentation for financial advisors in 2004. Have your views changed since then?

KRF: No, my views have not changed—at least on this topic. Here's the thrust of my 2004 presentation. The claims that, going forward, commodity funds

will have the same Sharpe ratio as the stock market,

will be negatively correlated with the returns on stocks and bonds,

will be a good hedge against inflation can't all be true.

Who would want the other side of this trade? The high volatility of commodity prices makes it impossible to accurately estimate the expected returns, volatilities, and covariances of commodity funds, but theory suggests that if commodity returns are negatively correlated with the rest of the market, the expected risk premium on commodities is small, perhaps negative. Finally, commodity funds are poor inflation hedges. Most of the variation in commodity prices is unrelated to inflation. In fact, commodity indices are typically 10 to 15 times more volatile than inflation. As a result, investors who use commodity funds to hedge inflation almost certainly increase the risk of their portfolios. Six years after my presentation, I still think these points are correct.
------------Kenneth French, 2010
You can sum up any active fund manager’s presentation at an investor conference in one sentence: “We’re doing well, all things considered.”
afan
Posts: 8191
Joined: Sun Jul 25, 2010 4:01 pm

Re: How Commodities Can Help a Portfolio

Post by afan »

I have to admit that comments like French's contribute to my skepticism, but mainly it is the disconnect between the data, the logic, and the implementation. One constructs an index that attempts to capture the return of the commodities market as a whole- to reproduce its different than stock or bond sensitivity to the business cycle. The index is constructed to be investable, for now don't worry about details of implementation. Study returns and find the index has low or negative correlations with both stocks and bonds. Based on this, conclude that the index can serve as a hedge.

Now create a fund that seeks to match the index, and hence produce the same covariance characteristics. At this point you do have to consider implementation. Devise an approach that avoids the pitfalls of perfectly matching the index. Before you invest in the fund it would seem the next step would be to confirm that the real world fund retains the covariance properties of then index on which one bases the overall strategy. If you now introduce more interest rate exposure by going longer on the collateral, one would again need to check that this had not increased correlation with the bond market or introduced stock-like sensitivity to the credit markets. Since the fund is actively managed, the performance of then index cannot tell you how the real world fund will behave.

Then, of course, one has to assume that the low and negative correlation of commodities with stocks and bonds will continue. This is different than assuming the Sharpe ratio of the commodities index will remain similar to that of stocks. If all that works out, and keeps working, then you have your hedge.

As I said, since PCRIX is interesting only as an example, not as something in which I would invest, it would be way too much trouble for me to check whether the list of commodities investments reflects an attempt to passively follow the UBS index. The fund clearly does invest in individual commodities, but that may be part of a strategy of matching the index. Given the turnover of such funds, any report of assets would be a snapshot of one instant in time, and another snapshot, minutes later, might look different.

Of course, one could also just hedge, without all this uncertainty.

I wonder how much of French's disinterest derives from the challenges of constructing his sort of rigorous academic study? These issues might make it difficult to create a representative index, identify the actual returns to investors, determine transaction costs and so forth. It might be impossible to produce a study that was informative about commodities investment, rather than the decisions on these issues.

Anyway, as a believer in efficient markets, I control my risk through the balance of stocks, bonds, real estate, and cash. I assume that the price of stocks includes the effects of the collective hedging of all investors. If I wanted to lower my risk further, I would reduce my stock exposure. In principle, I could use derivatives to hedge stock risk, but in reality I am no more going to do that than I would go for commodities. At least not until I see convincing data and analysis. You know, reproduced by finance professors around the country, using different approaches to obtaining the data, controlling for biases, estimating transaction costs, and all that stuff they do. Until then, the prospect of a tiny increase in Sharpe ratio is not nearly enough to make this approach to hedging worthwhile.

But hey, it is a free country. YMMV. That is what is great about capitalism.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

Re: How Commodities Can Help a Portfolio

Post by larryswedroe »

afan
Re French's comments. as I noted some of his comments are irrelevant and the others are "wrong"
it's easy to show that is true.
as to the irrelevant part---the use of CCF doesn't require the high Sharpe ratio that French refers to and Fama does also--While others may have relied on it (including Ferri who may have been performance chasing when he bought CCF, and there were no passive and relatively low costs funds either), no one I know expects that to happen nor relies on it when deciding to use commodities. Bradley keeps citing such comments as "proof" for his case but it's irrelevant, totally. As I have pointed out and others if you assume an asset has hedging qualities it must have low expected returns. That is the price you pay for the insurance. Doesn't mean you shouldn't own it. If that was true there would be no insurance industry.

As to French's comment on volatility, that is also true and irrelevant because that is only true in the ST. I was there when he first made that presentation. he showed one month correlations. Is your horizon one month? As I have pointed out and written as you extend maturity to any reasonable timeline the correlation of CCF to inflation rises to very significant levels, if memory serves it's like 70% at 4 years. So clearly anything with a high correlation like that is a hedge

As to your comment about TERM risk. First, if you use TIPS as PIMCO does as its main collateral then you can take term risk without any inflation risk, which is what you are worried about---and you earn that term premium. As to DFA they stick with ST bonds under 3 years, and the historical evidence is that is about the sweet spot on the yield curve, where it is steepest (years 0-3) and best rewarded. And with only 3 year max maturity there is not a lot of term risk/volatility anyway.

As to future correlations there are very simple and logical economic explanations which I have written on many times to explain and demonstrate why the correlations should be low/negative.

As to academics there are plenty of papers by people like Gorton and Rouwenhourst on the subject.

Good luck and best wishes
Larry
Bradley
Posts: 486
Joined: Tue May 01, 2007 2:41 pm

Re: How Commodities Can Help a Portfolio

Post by Bradley »

larryswedroe wrote: Bradley keeps citing such comments as "proof" for his case but it's irrelevant, totally.
Larry

I do not believe quoting the opinions, statements, recommendations of other highly respected investment professionals is irrelevant. According to you, Bogle is wrong. FF is wrong and/or irrelevant. Bernstein? and Ferri, our CFA, wrong! I think members may find their opinions helpful. Also sharing their recommendations with others will only help to enhance the discussion and show competing points of view.


Larry, have you ever expressed your concerns or asked DFA for their explanation on why they keep their posting of FF commodity opinion on their website even though they now sell a commodity fund? What are Bernstein’s concerns with using GSCI for doing research? Have you written to Mr Bogle to try to explain your thesis? I believe these men should be able to better explain why commodities/CCF’s make no sense in a portfolio and may share their research with you.


afan,
It is important to understand Larry’s research to understand why there is such a difference of opinion when it comes to Larry’s strategy. One should always look to the data to confirm or deny the strategy being studied. When we do that we find that out of five possible commodity indices the author chose but one to confirm his theory. When one passes over actual existing published data of an existing tradable index(CRB) and runs hypotheticals using back filled/tested data it should raise some concern over the efficacy of the study. What also raises a flag is using the GSCI when the recommended fund at the time was based on the DJ index. Why not use the DJ index to recommend a DJ tracking fund? This and many other inconsistencies led me to call the research silly. For example, pg 47 in the Alternative Investment book the hypothetical data starts in 1973. Why 1973? Why GSCI? Using backfilled data the study could have gone back much further but the data used in his book in table 3.7 arbitrarily started in 1973. 1973 hypothetical returns of the GSCI were 75% followed by 39.5% in 1974 raising substantially the returns of the commodity index from 1973-2007. French/Fama have rigorous standards when conducting their research and have obviously come to a different conclusion than Larry. Data, Data, Data is like location, location, location when looking at real estate as an investment, it must make sense.

Bradley
You can sum up any active fund manager’s presentation at an investor conference in one sentence: “We’re doing well, all things considered.”
TO39
Posts: 203
Joined: Fri Mar 14, 2008 10:01 am

Re: How Commodities Can Help a Portfolio

Post by TO39 »

to Bradley:


Larry has posted data from several different periods. You have posted none. The reason selecting 1973 is important is that was the start of a long period when long term treasuries and stocks were both doing badly as the following chart shows, It has 25% gold as the part of the portfolio that kept the portfolio on a much smoother ride. I think Larry is saying 10%CCF can do the same thing. He has supplied data supporting this. You have not. IMO


http://www.longtermreturns.com/p/histor ... 1__Bills_1
Roy
Posts: 970
Joined: Wed Sep 10, 2008 9:34 am

Re: How Commodities Can Help a Portfolio

Post by Roy »

Bradley wrote:
larryswedroe wrote: Bradley keeps citing such comments as "proof" for his case but it's irrelevant, totally.
Larry
I do not believe quoting the opinions, statements, recommendations of other highly respected investment professionals is irrelevant. According to you, Bogle is wrong. FF is wrong and/or irrelevant. Bernstein? and Ferri, our CFA, wrong! I think members may find their opinions helpful.
I do not find the catalogue of opinions helpful—in this thread or any other—and I respect all the authorities cited. I find evidence helpful—data—whether the source is an authority or not. So far, Larry is the only one who has supply any. Now there may be data that would refute his data-informed opinions but I haven't seen that yet. I don't own commodities but my choice has nothing to do with any opinions expressed here.
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

Re: How Commodities Can Help a Portfolio

Post by larryswedroe »

only one other comment, anyone who knows anything about commodities and investing in them would never even suggest using the CRB index, never. If you look at how the index is constructed you would know why and also understand why no one has ever created an investment based on it.

As to five indices referred to there are really just two that are generally used in academic papers on the subject , and I have shown the data for both and typically choosing the index that showed the worse results--the two are the DJ UBS and the GSCI

now other indices have been created by product providers, and unlike Rick I don't automatically assume they are bad or results of data mining., What I look for is logic and consistency to see if it is likely to a result of data mining or not

Now if anyone wants to dispute my statements on Fama and French's comments showing or explaining why my explanation is incorrect I would be happy to discuss/debate that (with anyone but Bradley who I will no longer discuss any issue with--so in case Bradley thinks I am ignoring him, he's right)

Larry
Bradley
Posts: 486
Joined: Tue May 01, 2007 2:41 pm

Re: How Commodities Can Help a Portfolio

Post by Bradley »

larryswedroe wrote:only one other comment, anyone who knows anything about commodities and investing in them would never even suggest using the CRB index, never.
Larry

Below are two separate operating funds based on the CRB. Below that are recent studies using the CRB.



GCC ------ GreenHaven Continuous Commodity Index is the least volatile and one of the more diversified broad-basket commodity exchange-traded funds. Most broad commodities funds weight their portfolios by economic significance, which results in a very high energy allocation (up to 70%) and a relatively low allocation to agriculture, metals, and "soft" commodities (coffee, sugar). GCC equally weights its 17 constituents, resulting in a diversified portfolio with a relatively higher weighting in agricultural commodities. Equal weighting is unusual for equity funds, but a common index strategy in academic research about commodities as an asset class. GCC's index methodology also addresses the peculiarities and potential downsides of tracking commodity futures. All commodity funds are expensive, but GCC's 1.05% total annual cost is particularly high, due to GCC's daily rebalancing, which racks up extra brokerage fees.


CRBQ -------- Jefferies CRB Global Commodity







How Do Commodity Futures Respond to Macroeconomic News?

Financial Markets and Portfolio Management, Vol. 22, No. 2, pp. 127-146, 2008



Alternative Assets: A Comparison between Commodities and Traditional Asset Classes

University Journal of Derivatives Markets, Vol. 6, No. 2, April 2009


Strategic Asset Allocation and Intertemporal Hedging Demands: With Commodities as an Asset Class
You can sum up any active fund manager’s presentation at an investor conference in one sentence: “We’re doing well, all things considered.”
MCSquared
Posts: 259
Joined: Sun Aug 02, 2009 7:59 pm

Re: How Commodities Can Help a Portfolio

Post by MCSquared »

Bradley wrote:
larryswedroe wrote: Bradley keeps citing such comments as "proof" for his case but it's irrelevant, totally.
Larry

I do not believe quoting the opinions, statements, recommendations of other highly respected investment professionals is irrelevant. According to you, Bogle is wrong. FF is wrong and/or irrelevant. Bernstein? and Ferri, our CFA, wrong! I think members may find their opinions helpful. Also sharing their recommendations with others will only help to enhance the discussion and show competing points of view.


Larry, have you ever expressed your concerns or asked DFA for their explanation on why they keep their posting of FF commodity opinion on their website even though they now sell a commodity fund? What are Bernstein’s concerns with using GSCI for doing research? Have you written to Mr Bogle to try to explain your thesis? I believe these men should be able to better explain why commodities/CCF’s make no sense in a portfolio and may share their research with you.


afan,
It is important to understand Larry’s research to understand why there is such a difference of opinion when it comes to Larry’s strategy. One should always look to the data to confirm or deny the strategy being studied. When we do that we find that out of five possible commodity indices the author chose but one to confirm his theory. When one passes over actual existing published data of an existing tradable index(CRB) and runs hypotheticals using back filled/tested data it should raise some concern over the efficacy of the study. What also raises a flag is using the GSCI when the recommended fund at the time was based on the DJ index. Why not use the DJ index to recommend a DJ tracking fund? This and many other inconsistencies led me to call the research silly. For example, pg 47 in the Alternative Investment book the hypothetical data starts in 1973. Why 1973? Why GSCI? Using backfilled data the study could have gone back much further but the data used in his book in table 3.7 arbitrarily started in 1973. 1973 hypothetical returns of the GSCI were 75% followed by 39.5% in 1974 raising substantially the returns of the commodity index from 1973-2007. French/Fama have rigorous standards when conducting their research and have obviously come to a different conclusion than Larry. Data, Data, Data is like location, location, location when looking at real estate as an investment, it must make sense.

Bradley
While I don't necessarily agree with your continuing "appeal to authority" argument, do you realize that two of the greatest investors in the world, Carlos Slim and Warren Buffett, have both invested in commodities? I think at one time Buffett owned 130 million ounces of silver which was the largest single position in the market.
Bradley
Posts: 486
Joined: Tue May 01, 2007 2:41 pm

Re: How Commodities Can Help a Portfolio

Post by Bradley »

Roy wrote: I don't own commodities but my choice has nothing to do with any opinions expressed here.
Hi Roy,

I don't own commodities either. Below is some data that may surprise some.


As meaningless as they are in determining which funds will outperform in the future, they do tell us what was the most productive commodity fund among the three displayed below. For now, the two CRB based funds lead the GSCI in both cases



It appears that both commodity funds based on the CRB have outperformed PCRIX using the longest data available on M* retail site.


5 Year GCC lost 4.98 (NAV)
5 Year PCRIX lost 6.78 NAV

CRB based GCC outperformed PCRIX by 1.89% over the 5 year period
((All periods greater than 1-Year are annualized. GCC (Price) return as of 06/07/2013.))




3 Year CRBQ NAV increased 7.63% over period

3 Year PCRIX NAV increased 7.00% over period


CRB based CRBQ outperformed PCRIX over the longest period measure by M*.
(( All periods greater than 1-Year are annualized. GCC (Price) return as of 06/07/2013.))



No one can tell if these results will continue in the future. Only time will tell. For now, the evidence points to the CRB indices as being the superior strategy using the available performance results. Those with crystal balls can make there own claims about the future.
You can sum up any active fund manager’s presentation at an investor conference in one sentence: “We’re doing well, all things considered.”
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

Re: How Commodities Can Help a Portfolio

Post by larryswedroe »

for those interested the data above posted by Bradley is totally meaningless and not for the reason that one normally might think--like the period is short
It's meaningless because one has to look at how the returns of the investment mix with the returns of the rest of the portfolio

as I have shown even over long periods when the GSCI underperformed the DJ UBS index when used in a portfolio the net impact was virtually identical. Looking at the impact in isolation tells you nothing at all of any value. by now this should be clear to anyone.

And yes the CRB was a meaningless and useless index which no one used which is why it was totally changed, I think in 2005 and Thomson Reuteurs I think took it over and changed it to try and make it meaningful. Data from the early years has no value.
Larry
Bradley
Posts: 486
Joined: Tue May 01, 2007 2:41 pm

Re: How Commodities Can Help a Portfolio

Post by Bradley »

larryswedroe wrote: the data above posted by Bradley is totally meaningless
Larry
Larry,

If you reread my post you will see I already said it was meaningless data. It does however show that the two separate CRB index based funds did outperform your PRCIX fund. If it does so in the future, neither you or I know. I posted only to add balance to your claim;

"larryswedroe wrote:only one other comment, anyone who knows anything about commodities and investing in them would never even suggest using the CRB index, never."


It appears both CRB funds have outperformed so never may have been an overreach. If the data I posted is in error please provide the correct data.

Thanks,
Bradley
You can sum up any active fund manager’s presentation at an investor conference in one sentence: “We’re doing well, all things considered.”
Roy
Posts: 970
Joined: Wed Sep 10, 2008 9:34 am

Re: How Commodities Can Help a Portfolio

Post by Roy »

Hi, Bradley,

Comparing Navs or Returns in isolation is usually (if not always) not helpful, though it is often done even by "experts". The portfolio as a whole is what matters. As Larry has said for years, this is the most important point (Larry didn't manufacture that concept, but speaks to it a lot for good reason), and this subsumes all asset classes in the portfolio, not just CCFs.

Regarding future returns or correlations—between any asset class or funds—of course we cannot be sure they will be as they have been. This also applies to the Equity Risk Premium, the extra premia of Small and Value, and other asset class comparatives. But this does not mean that past data or correlations are useless, just not assured.

So, CCFs are not special in this way, even as they appear more complex and volatile than some other asset classes, and the precise timing of correlations can matter greatly with volatile components, which is why a small amount can mean a lot to the portfolio, depending on that volatility (this is true for Gold also, as can be seen in past—but not future assured— data). I do not have a great understanding of CCFs but that is my understanding of how this operates.
Bradley
Posts: 486
Joined: Tue May 01, 2007 2:41 pm

Re: How Commodities Can Help a Portfolio

Post by Bradley »

larryswedroe wrote: anyone who knows anything about commodities and investing in them would never even suggest using the CRB index, never.

Larry

Roy,

I agree with your post. I simply posted information which showed the claim above may be overreaching. Many investors do invest in the CRB based commodity funds. Those who did, outperformed according to data published by M*. Which funds will outperform in the future cannot be determined at this time.

Bradley
You can sum up any active fund manager’s presentation at an investor conference in one sentence: “We’re doing well, all things considered.”
pop77
Posts: 544
Joined: Wed Dec 12, 2007 6:57 pm

Re: How Commodities Can Help a Portfolio

Post by pop77 »

Here is an excellent presentation of his 7twelve portfolio by Craig L. Israelsen. In this presentation he talks about the diversification benefits of multiple assets which includes commodities. I stumbled upon his writings when he wrote another excellent piece on role of bonds in the latest issue if AAII. The whole presentation is worth watching, but for those who are short on time the link I provided starts at 20 minutes. Please watch at least till 33 minutes, where he outlines how adding commodities brings the risk down. I was impressed by this presentation. Love to hear your thoughts.

http://youtu.be/8rTBEZSL7-4?t=20m31s
Bradley
Posts: 486
Joined: Tue May 01, 2007 2:41 pm

Re: How Commodities Can Help a Portfolio

Post by Bradley »

Thanks for posting Craig’s video, very good info and well presented. Craig has written hundreds of articles for Financial Planning over the years. Many years ago I e-mailed him a question about one of his articles. He responded that same evening with a clear and concise explanation and in addition sent all the raw data he used in spreadsheet form. He and Rick collaborated on a very informative article titled “Is a Pension a Bond?” within the past 5 years. Many of his latest articles can be found here:


http://www.financial-planning.com/thoug ... elsen.html
You can sum up any active fund manager’s presentation at an investor conference in one sentence: “We’re doing well, all things considered.”
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

Re: How Commodities Can Help a Portfolio

Post by larryswedroe »

note my comment on the CRB index to repeat, to be perfectly clear (at least for those that care to actually read)
The CRB index WAS not designed to be investable in any way--it was useless for looking at returns to a CCF strategy
Thus the data based on it was not valuable
That now changed when Thomson Reuters took it over and tried to commercialize it so they could license it, so they changed how it was constructed, making it similar to the DJ UBS in concept, more equal type weighting to avoid the high energy concentration of the GSCI which is production weighted. IMO both concepts have good logic to them
So my comment on the CRB was related to using it to look at HISTORICAL returns back to I think it's 1958--in that sense it was useless.

With more research and time it's likely more indices and products may become available---but only two will give us good historical data and gsci back to 1970 and dj ubs to 1991. The CRB may not be okay since 2005

Larry
User avatar
rmelvey
Posts: 826
Joined: Sat Sep 18, 2010 5:17 pm
Contact:

Re: How Commodities Can Help a Portfolio

Post by rmelvey »

Another important thing to keep in mind is that gold and silver have been perfectly investable in since the early 1970s. I think squabbling over the commodity indices is missing the bigger picture. One can use gold and silver as a proxy for the commodity universe and understand the diversification story using very clean data.

Commodities round out an investment portfolio, protecting stocks/bonds from their achilles heel: supply shock inflations. The data and logic are both super clear on this. The trick is that you have to always adjust your returns for inflation before doing your risk/return metrics because commodities do a better job at reducing your standard deviation of real returns within the context of an already diversified stock/bond portfolio.
Bradley
Posts: 486
Joined: Tue May 01, 2007 2:41 pm

Re: How Commodities Can Help a Portfolio

Post by Bradley »

MCSquared wrote:

Carlos Slim and Warren Buffett, have both invested in commodities?

Morning MC,

There is a oft quoted saying, "If you look in the mirror and don't see Warren Buffett, don't try to invest like him". It is also a fact that Warren is not a fan of commodities as part of any strategic allocation. Below are a few of his quotes, many apply to one specific commodity, gold, but the logic applies to all commodities.



1.“The problem with commodities is that you are betting on what someone else would pay for them in six months. The commodity itself isn’t going to do anything for you….it is an entirely different game to buy a lump of something and hope that somebody else pays you more for that lump two years from now than it is to buy something that you expect to produce income for you over time.”



2. “Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”



3. “Gold is a way of going long on fear, and it has been a pretty good way of going long on fear from time to time. But you really have to hope people become more afraid in a year or two years than they are now. And if they become more afraid you make money, if they become less afraid you lose money, but the gold itself doesn’t produce anything."



4. “I will say this about gold. If you took all the gold in the world, it would roughly make a cube 67 feet on a side…Now for that same cube of gold, it would be worth at today’s market prices about $7 trillion – that’s probably about a third of the value of all the stocks in the United States…For $7 trillion…you could have all the farmland in the United States, you could have about seven Exxon Mobils and you could have a trillion dollars of walking-around money…And if you offered me the choice of looking at some 67 foot cube of gold and looking at it all day, and you know me touching it and fondling it occasionally…Call me crazy, but I’ll take the farmland and the Exxon Mobils.”




5. “The major asset in this category is gold, currently a huge favorite of investors who fear almost all other assets, especially paper money (of whose value, as noted, they are right to be fearful). Gold, however, has two significant shortcomings, being neither of much use nor procreative. True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end.”




6. “What motivates most gold purchasers is their belief that the ranks of the fearful will grow. During the past decade that belief has proved correct. Beyond that, the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis. As 'bandwagon' investors join any party, they create their own truth — for a while."




7. “I have no views as to where it will be, but the one thing I can tell you is it won’t do anything between now and then except look at you.  Whereas, you know, Coca-Cola will be making money, and I think Wells Fargo will be making a lot of money and there will be a lot — and it’s a lot — it’s a lot better to have a goose that keeps laying eggs than a goose that just sits there and eats insurance and storage and a few things like that.
You can sum up any active fund manager’s presentation at an investor conference in one sentence: “We’re doing well, all things considered.”
Bradley
Posts: 486
Joined: Tue May 01, 2007 2:41 pm

Re: How Commodities Can Help a Portfolio

Post by Bradley »

Dan Solin is another very well rounded investment advisor to the wealthy that has an opinion on adding commodities as a separate asset class to your portfolio.

Question: Is now the right time to invest in commodities?

“Personally, I am content with the commodities exposure I receive by owning a broadly diversified domestic index stock fund. I do not have exposure to commodities as a separate asset class in my portfolio and I do not recommend it for inclusion in the portfolios of my clients.”
-------------Dan Solin Jun 11, 2008


Below is a reference to a book presentation he gave at Google.

http://www.youtube.com/watch?v=Y0LSG2omvEg

Book was good and Taylor has posted the GEMS from it.
You can sum up any active fund manager’s presentation at an investor conference in one sentence: “We’re doing well, all things considered.”
MCSquared
Posts: 259
Joined: Sun Aug 02, 2009 7:59 pm

Re: How Commodities Can Help a Portfolio

Post by MCSquared »

Bradley wrote:
MCSquared wrote:

Carlos Slim and Warren Buffett, have both invested in commodities?

Morning MC,

There is a oft quoted saying, "If you look in the mirror and don't see Warren Buffett, don't try to invest like him". It is also a fact that Warren is not a fan of commodities as part of any strategic allocation. Below are a few of his quotes, many apply to one specific commodity, gold, but the logic applies to all commodities.



1.“The problem with commodities is that you are betting on what someone else would pay for them in six months. The commodity itself isn’t going to do anything for you….it is an entirely different game to buy a lump of something and hope that somebody else pays you more for that lump two years from now than it is to buy something that you expect to produce income for you over time.”



2. “Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”



3. “Gold is a way of going long on fear, and it has been a pretty good way of going long on fear from time to time. But you really have to hope people become more afraid in a year or two years than they are now. And if they become more afraid you make money, if they become less afraid you lose money, but the gold itself doesn’t produce anything."



4. “I will say this about gold. If you took all the gold in the world, it would roughly make a cube 67 feet on a side…Now for that same cube of gold, it would be worth at today’s market prices about $7 trillion – that’s probably about a third of the value of all the stocks in the United States…For $7 trillion…you could have all the farmland in the United States, you could have about seven Exxon Mobils and you could have a trillion dollars of walking-around money…And if you offered me the choice of looking at some 67 foot cube of gold and looking at it all day, and you know me touching it and fondling it occasionally…Call me crazy, but I’ll take the farmland and the Exxon Mobils.”




5. “The major asset in this category is gold, currently a huge favorite of investors who fear almost all other assets, especially paper money (of whose value, as noted, they are right to be fearful). Gold, however, has two significant shortcomings, being neither of much use nor procreative. True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end.”




6. “What motivates most gold purchasers is their belief that the ranks of the fearful will grow. During the past decade that belief has proved correct. Beyond that, the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis. As 'bandwagon' investors join any party, they create their own truth — for a while."




7. “I have no views as to where it will be, but the one thing I can tell you is it won’t do anything between now and then except look at you.  Whereas, you know, Coca-Cola will be making money, and I think Wells Fargo will be making a lot of money and there will be a lot — and it’s a lot — it’s a lot better to have a goose that keeps laying eggs than a goose that just sits there and eats insurance and storage and a few things like that.
Bradley, thanks for your response. Humor me and let's follow your logic for a moment. Can I assume that you do not invest in equities, commodities, bonds, convertibles, preferred equity etc.? After all, you don't see Warren Buffett when you look in the mirror and those are some of the vehicles he certainly invests in. I mean, we all know that we shouldn't try to invest like him, yes? Further, since you don't see Ferri, Bernstein, Bogle, Fama, French, etc. when you look in the mirror can we assume you can't invest like they do either? This is rhetorical but I hope you understand my point.

Relative to Buffett, you forgot to find the quote explaining why he bought 130 million ounces of silver (roughly 20% of the entire world supply at the time). Since we know for a fact that he is not a fan of commodities, why make this type of investment?
Bradley
Posts: 486
Joined: Tue May 01, 2007 2:41 pm

Re: How Commodities Can Help a Portfolio

Post by Bradley »

MCSquared wrote: Relative to Buffett, you forgot to find the quote explaining why he bought 130 million ounces of silver (roughly 20% of the entire world supply at the time). Since we know for a fact that he is not a fan of commodities, why make this type of investment?


http://bit.ly/ZICKqV
You can sum up any active fund manager’s presentation at an investor conference in one sentence: “We’re doing well, all things considered.”
Bradley
Posts: 486
Joined: Tue May 01, 2007 2:41 pm

Re: How Commodities Can Help a Portfolio

Post by Bradley »

larryswedroe wrote:afan
First, PIMCO is totally passive on the commodity side in terms of exposure to the commodities. Their active component is only trading on different exchanges to get better prices. So it's totally passive

Second, here is where Rick and I very much disagree. To him if it's not totally passive it's not good.



Larry

You can't be just a little pregnant.


This is what PIMCO claims on it's website. They state that they do actively manage their commodity exposure. Much of what is guessed about is easily confirmed or denied by simply asking or verifying with the product providers published data/information.




PCRIX

"Why Invest In This Fund

A Double RealTM inflation-hedging strategy

Combining the benefits of commodities with the experience of PIMCO as an active manager of commodities and fixed income collateral, the fund seeks to outperform the Dow Jones-UBS Commodity Total Return Index by actively managing both the commodities exposure and the underlying TIPS collateral portfolio. TIPS may decline in value if interest rates rise, and may be particularly sensitive if real interest rates rise rapidly."





How can it be totally passive if the product provider warns us that it IS actively managed?
You can sum up any active fund manager’s presentation at an investor conference in one sentence: “We’re doing well, all things considered.”
afan
Posts: 8191
Joined: Sun Jul 25, 2010 4:01 pm

Re: How Commodities Can Help a Portfolio

Post by afan »

The short term performance of this fund (PCRIX) since April suggests that there is no free lunch. The higher than index returns were apparently due to longer than T bills maturity on the collateral. As interest rates have risen the fund has underperformed its index substantially. This appears to be due to adding interest rate risk to the fund beyond that seen in the index. Nothing wrong with that of course, as long as you recognize that is what you are doing. The "free" lunch occurred during an extended period of falling interest rates. If those days are over, if rates are now rising, then interest extra rate risk is not necessarily desirable.

Whether or not you want more interest rate risk, it is important not to conflate this with "commodities", or to assume that the low correlation of COMMODITIES with bonds will apply to a FUND that explicitly invests in longer duration fixed income to boost returns. You can index your commodities exposure, if you seek such exposure, and select the interest rate risk of your portfolio by your selection of bond funds. You don't need to pay a manager to do this for you, and leave you uncertain as to how much interest rate risk you have assumed.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

Re: How Commodities Can Help a Portfolio

Post by larryswedroe »

Afan
SOME of the outperformance was clearly related to the inclusion of high allocation to TIPS and the huge rally that occurred as real rates fell--but with that said, that doesn't mean it was not a good strategy. Again, owning TIPS allows you to extend on the curve without the inflation risk you get with nominal bonds---

The rest of the outperformance was due to intelligent design of trading, avoiding the 5 required trading dates for rolling over maturities and avoiding always trading in the near month--those benefits are highly likely to persist--just a negative of indexing (transparency that allows active traders to exploit known trades of indexers). Note the avoiding the near month is also based on academic research

Now I still have problems as I mentioned with PCRIX due to more credit risk taking than I care for

Hope that helps
Larry
afan
Posts: 8191
Joined: Sun Jul 25, 2010 4:01 pm

Re: How Commodities Can Help a Portfolio

Post by afan »

Again, I don't have any particular like or dislike of the fund. Just pointing out that as soon as a fund stops simply following an index one can no longer predict fund performance from index performance. if you want to use historical index performance as a guide then you need a fund that tracks the index. If construction of the index makes it difficult to track then you either need a different index or a fund that manages to overcome the limitations of the index. If a fund manages to do this without introducing new risks then it should track the index and you can use index performance as a guide for expected performance. As soon as the fund tries to beat the index it stops tracking it. That means you can no longer assume it will provide the same hedging properties as the index.. This may be fine if the investor knows how the risk exposure has deviated from the index, and can compensate in the rest of the portfolio, and is willing to do so.

But if the deviations from the index are obscure or can change then it becomes impossible to know what you are hedging. For a hedge, outperforming the index is irrelevant. One cares about covariance with the thing one is trying to hedge. If you know that the fund's returns are part commodities, part bond fund, then you can invest accordingly. But it would be meaningless to say the fund outperformed the index because the bond part did better than T bills.

As I said, this is purely curiosity for me, but I still wonder why one would do this. if you want to hedge stocks, there would seem to be more direct ways of doing this. And you can invest your collateral at whatever interest rare risk you want. Just don't congratulate yourself for your hedging ability when your bonds did well.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

Re: How Commodities Can Help a Portfolio

Post by larryswedroe »

AFan
Yes I agree you cannot predict relative return, but that isn't the issue. The issue is simply: is the strategy design likely to under or outperform the benchmark index? If it outperforms and is clear then you should be glad. There is nothing special about matching an index.

What most indexers fail to understand is that the index design matters in terms of implementation, and it can matter either very little or a great deal. In the case of CCF it matters a great deal and only a poorly run fund would follow the index as it's mandate because doing so can easily cost 2% a year or more, forgetting even the issue of collateral management, which can also likely add value with minimal risk

The issue with the PIMCO fund is that they became quite active in the collateral management, more active than I was led to believe, which is why I switched to recommending the DFA fund and there is nothing opaque about it's collateral management which is the DFA ST extended credit fund (and you can account for that in your overall asset allocation) and it doesn't change the nature of the hedge, though neither did PIMCOs basically, though perhaps to a small degree because it owned a small percent of riskier bonds (hurting during the demand shock(

The hedge on stocks that you refer to only applies to DEMAND shocks, while owning safe bonds won't help you with supply shocks.
And you seem to be missing that CCF also hedges (much better in fact) the risk of unexpected inflation--which allows you to then extend on the yield curve further than if you don't own CCF.
So it's hedging the entire portfolio's risk, not just the stock side

I hope that is helpful
Larry
Post Reply