my commodity exposure is getting killed

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Topic Author
Manbaerpig
Posts: 1368
Joined: Wed Mar 09, 2011 1:32 am
Location: San Jose

my commodity exposure is getting killed

Post by Manbaerpig »

:oops:


7% in 2 days
User avatar
Scott S
Posts: 1937
Joined: Mon Nov 24, 2008 2:28 am
Location: building my position

Post by Scott S »

I can't remember who said it first, but being diversified means you're always unhappy with something in your portfolio.

- Scott
"Old value investors never die, they just get their fix from rebalancing." -- vineviz
Topic Author
Manbaerpig
Posts: 1368
Joined: Wed Mar 09, 2011 1:32 am
Location: San Jose

Post by Manbaerpig »

never thought of it that way :P
User avatar
CyberBob
Posts: 3387
Joined: Tue Feb 20, 2007 1:53 pm

Post by CyberBob »

Scott S wrote:I can't remember who said it first, but being diversified means you're always unhappy with something in your portfolio.

- Scott
Peter L. Bernstein often said the following:
  • “Many years ago an associate said to me [that] you’re not really diversified unless you own something you’re uncomfortable with. It was a wise statement. Because if you’re comfortable with all your holdings, they probably have the same flavor and are going to respond to the same set of forces."
Bob
hlfo718
Posts: 808
Joined: Wed Dec 01, 2010 8:17 am
Location: NYC

Post by hlfo718 »

But your fixed income should have cushion part of the drop.
User avatar
bob90245
Posts: 6511
Joined: Mon Feb 19, 2007 7:51 pm

Post by bob90245 »

Scott S wrote:I can't remember who said it first, but being diversified means you're always unhappy with something in your portfolio.

- Scott
Commodity funds seem to make investors unhappy no matter what. They don't go up very much when commodities go up, but they sure go down when commodities go down. It's a "heads I lose, tails I lose". :cry:
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.
User avatar
stemikger
Posts: 4950
Joined: Thu Apr 08, 2010 5:02 am

Post by stemikger »

From what I read commodity funds are not part of the Bogglehead philosophy.

Here is what John Bogle says about commodity funds:

Don't own them. Of course, there will be commodity bubbles that will attract you only after they have inflated to absurd proportions. But unlike stocks and bonds, commodities have no fundamentals to support them (neither earnings and dividends nor interest payments).

This is from The Little Book of Common Sense Investing.
User avatar
HomerJ
Posts: 21282
Joined: Fri Jun 06, 2008 12:50 pm

Post by HomerJ »

stemikger wrote:From what I read commodity funds are not part of the Bogglehead philosophy.

Here is what John Bogle says about commodity funds:

Don't own them. Of course, there will be commodity bubbles that will attract you only after they have inflated to absurd proportions. But unlike stocks and bonds, commodities have no fundamentals to support them (neither earnings and dividends nor interest payments).

This is from The Little Book of Common Sense Investing.
Heh, I hate to say this about one of John Bogle's writings.... but if "of course there will be commodity bubbles" then owning a commodity fund all the time (AND REBALANCING) should be a very wise move.
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

ccf

Post by larryswedroe »

First if going to think of CCF in isolation, never buy them
Second, as I noted if going to buy CCF as insurance against some risks you have to understand that they don't protect against all risks, just some--like fire insurance doesn't protect against floods or earthquakes. Want that protection need to buy that insurance

Third as I have noted, CCF doesn't help against deflationary shocks like 2008 or the Japan type event. They help against other types.

Fourth, I also have recommended that if going to add CCF one should also consider adding duration risk as CCF hedges bond risks even better than it hedges equity risks---never down year for bonds when CCF also down.

Fifth, also recommended that if going to own CCF should take the allocation from the equity side, not the bond side. So if followed all the advice then you lost less from equities than would have otherwise and your bonds would have made more than otherwise so perhaps the end result not so bad. And now you get chance to rebalance, buying low and selling high, relatively speaking.

Hope that helps

Best wishes
Larry
staythecourse
Posts: 6993
Joined: Mon Jan 03, 2011 8:40 am

Post by staythecourse »

If you don't understand how an invesment works you shouldn't invest in it. Commodities are very volatile and aren't expected to to well unless there is high inflation like in the 70's or unless there is a actual or fear of a supply shock of oil (at least for oil rich commodity plays). Outside of that period I don't expect them to do much other than help give a better risk/ reward for the portfolio as a whole via lower correlations. As Darst mentions in his book commodities don't follow economical cycles thus the reason the have diversification benefits.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle
Tuxx
Posts: 863
Joined: Tue Mar 30, 2010 1:19 am

Post by Tuxx »

Margain calls. People have to sell winners to make margain.

Inflation is on fire:

Released on 3/15/2011 8:30:00 AM For Feb, 2011

Export Prices - M/M change 1.2 %
Export Prices - Y/Y change 8.6 %
Import Prices - M/M change 1.4 %
Import Prices - Y/Y change 6.9 %
User avatar
Random Musings
Posts: 6771
Joined: Thu Feb 22, 2007 3:24 pm
Location: Pennsylvania

Post by Random Musings »

I thought part of the charm with commodities was the volatility as well as an asset class that has favorable correlation characteristics.

Stick with your financial game plan and rebalance if necessary.

RM
User avatar
LH
Posts: 5490
Joined: Wed Mar 14, 2007 2:54 am

Post by LH »

bob90245 wrote:
Scott S wrote:I can't remember who said it first, but being diversified means you're always unhappy with something in your portfolio.

- Scott
Commodity funds seem to make investors unhappy no matter what. They don't go up very much when commodities go up, but they sure go down when commodities go down. It's a "heads I lose, tails I lose". :cry:
Thats interesting.

Is there some sort of graphical representation of this? Or numerical support of this?

Thanks,

LH
User avatar
bob90245
Posts: 6511
Joined: Mon Feb 19, 2007 7:51 pm

Post by bob90245 »

LH wrote:
bob90245 wrote:
Scott S wrote:I can't remember who said it first, but being diversified means you're always unhappy with something in your portfolio.

- Scott
Commodity funds seem to make investors unhappy no matter what. They don't go up very much when commodities go up, but they sure go down when commodities go down. It's a "heads I lose, tails I lose". :cry:
Thats interesting.

Is there some sort of graphical representation of this? Or numerical support of this?
Detailed in this article:

Amber Waves of Pain
Lured by the idea of profiting from raw materials, investors put $277 billion into commodity ETFs and related securities by the end of 2009. Then they noticed a problem: When commodities go up, the commodity ETFs often don't.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.
Topic Author
Manbaerpig
Posts: 1368
Joined: Wed Mar 09, 2011 1:32 am
Location: San Jose

Re: my commodity exposure is getting killed

Post by Manbaerpig »

Morgan wrote:
Manbaerpig wrote::oops:


7% in 2 days
What is your commodity exposure as a % of your asset allocation?
nearly 6%

going against the grain here I suppose (literally+figuratively), but my reading on commodities is that over the last 40 years they have offered increased diversification and lowered risk to portfolios and shouldnt be discounted, I also believe they are a great inflation play, which in my opinion is rather timely looking at the sheer speed and volume of the printing presses running worldwide

I don't think Bogle would be against some commodity exposure given developments on the QE front worldwide
User avatar
bob90245
Posts: 6511
Joined: Mon Feb 19, 2007 7:51 pm

Re: my commodity exposure is getting killed

Post by bob90245 »

Manbaerpig wrote:... my reading on commodities is that over the last 40 years they have offered increased diversification and lowered risk to portfolios and shouldnt be discounted ...
The data you've read are only on paper. Results could be different when running real money portfolios.
Manbaerpig wrote:... I also believe they are a great inflation play, which in my opinion is rather timely looking at the sheer speed and volume of the printing presses running worldwide

I don't think Bogle would be against some commodity exposure given developments on the QE front worldwide
No one has clear crystal balls. So what you are saying is only a guess, including guessing what Jack Bogle is thinking. It could also be that any anomalies found related to commodity strategies in the past will diminish or disappear as investors try to exploit these anomalies.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.
staythecourse
Posts: 6993
Joined: Mon Jan 03, 2011 8:40 am

Post by staythecourse »

The government has done studies to find out if the future spot prices that were being predicited in the futures market was accurate enough for them to use to help price out commodities, but all the data shows not surprisingly that no one is good at predicting future spot prices (just like no one can predict the future). If no one can predict the future then how would people consistently make money of "strategies"?

If there is one similarity it would seem that the buy and hold would be the best route as more active trading causes the market to be more efficient.

Just my opinion.

BTW, I don't think Mr. Bogle would approve of any speculatory asset class which commodities falls into. But then again he doesn't agree with anything other then TSM and TBM.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

stay the course

Post by larryswedroe »

Used properly, or bought for the right reasons, commodity investment is about the furthest thing thing from speculation as you can get, as the right reason to own it is for purpose of portfolio insurance (not speculation)

Best wishes
Larry
staythecourse
Posts: 6993
Joined: Mon Jan 03, 2011 8:40 am

Re: stay the course

Post by staythecourse »

larryswedroe wrote:Used properly, or bought for the right reasons, commodity investment is about the furthest thing thing from speculation as you can get, as the right reason to own it is for purpose of portfolio insurance (not speculation)

Best wishes
Larry
I completely agree. I was referring to other experts suggestions it is a speculation.

BTW, I loved the 1 page or so description of commodities from you latest book. Summed up the reasoning for commodities in a portfolio.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle
User avatar
Majormajor78
Posts: 910
Joined: Mon Jan 31, 2011 8:13 pm

Post by Majormajor78 »

LH wrote:
bob90245 wrote:
Scott S wrote:I can't remember who said it first, but being diversified means you're always unhappy with something in your portfolio.

- Scott
Commodity funds seem to make investors unhappy no matter what. They don't go up very much when commodities go up, but they sure go down when commodities go down. It's a "heads I lose, tails I lose". :cry:
Thats interesting.

Is there some sort of graphical representation of this? Or numerical support of this?

Thanks,

LH
You need to understand contango. Read this article. I'm not sure where I originally came across it but is certainly convinced me to never invest in a commodity fund.

http://www.businessweek.com/magazine/co ... 970461.htm

Here's a copy of the largest oil ETF's prospectus USO. The thing is 128 pages long (all fine print to boot)!!! Doesn't anybody read the prospectus before they buy!? Of course not. That would be hard :cry: and who needs to understand how commodity future funds work when the guys on TV squawk INFLATION! INFLATION! like a parot and then talk about how commodities are going to run up in response. Maybe they're right, maybe not but those commodity funds are doomed to lose money over the long haul.

http://www.unitedstatesoilfund.com/pdfs ... pectus.pdf

EDIT: Here's your graph http://www.businessweek.com/magazine/co ... 972561.htm

Another edit: Just noticed this has already been posted... never blog while you have a fever... :oops:
"Oh, M. le Comte, it is only a loss of money which I have sustained... nothing worth mentioning, I assure you."
User avatar
tetractys
Posts: 6249
Joined: Sat Mar 17, 2007 3:30 pm
Location: Along the Salish Sea

Re: ccf

Post by tetractys »

larryswedroe wrote:First if going to think of CCF in isolation, never buy them
Second, as I noted if going to buy CCF as insurance against some risks you have to understand that they don't protect against all risks, just some--like fire insurance doesn't protect against floods or earthquakes. Want that protection need to buy that insurance

Third as I have noted, CCF doesn't help against deflationary shocks like 2008 or the Japan type event. They help against other types.

Fourth, I also have recommended that if going to add CCF one should also consider adding duration risk as CCF hedges bond risks even better than it hedges equity risks---never down year for bonds when CCF also down.

Fifth, also recommended that if going to own CCF should take the allocation from the equity side, not the bond side. So if followed all the advice then you lost less from equities than would have otherwise and your bonds would have made more than otherwise so perhaps the end result not so bad. And now you get chance to rebalance, buying low and selling high, relatively speaking.
That's quite a list to juggle in order to make commodities worth the trouble. One addition might be that CCF costs must be kept way down to maintain hopes of any negligible expected benefit. Somehow this all reminds me of Steve Martin's "cruel shoes."

IMO CCF are more apropos for the dancing shoes of a speculator. I just don't think they would come with a very high rating as an insurance policy, even for "other"--I mean, where's the guarantee, and for what? -- Tet
rustymutt
Posts: 4001
Joined: Sat Mar 07, 2009 11:03 am

Re: my commodity exposure is getting killed

Post by rustymutt »

Manbaerpig wrote::oops:


7% in 2 days
So what lesson have you learned about commodities that you would share with the rest of the flock here at Bogleheads? And may I ask you why you had commodities? As I read through Larry's book, I decided that commodities had no place in my investment portfolio.
Even educators need education. And some can be hard headed to the point of needing time out.
Topic Author
Manbaerpig
Posts: 1368
Joined: Wed Mar 09, 2011 1:32 am
Location: San Jose

Post by Manbaerpig »

"don't peek", I think is the lesson I learned.

Probably not the one you were looking for, I gather.
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

TET

Post by larryswedroe »

First IMO it is pretty simple and straight forward.
Second, negligible benefit? As both I and Bill Bernstein have shown (in his case with PME) the low correlation and high volatility produce a diversification return of perhaps 4-5%
Now costs due matter and the contango in energy is creating a problem---though it doesn't really exist elsewhere to much if any degree. Is it permanent or temporary? No clue, as my crystal ball always cloudy
User avatar
tetractys
Posts: 6249
Joined: Sat Mar 17, 2007 3:30 pm
Location: Along the Salish Sea

Re: TET

Post by tetractys »

larryswedroe wrote:First IMO it is pretty simple and straight forward.
Second, negligible benefit? As both I and Bill Bernstein have shown (in his case with PME) the low correlation and high volatility produce a diversification return of perhaps 4-5%
Now costs due matter and the contango in energy is creating a problem---though it doesn't really exist elsewhere to much if any degree. Is it permanent or temporary? No clue, as my crystal ball always cloudy
PME = Precious Metals Equity? 4-5%; nominal for the asset itself?

Larry, I think you just through me a rubber chicken. Thanks, I've always wanted one of those. -- Tet
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

TET

Post by larryswedroe »

need to be able to read more carefully---I said that Bill Bernstein found that the diversification return (what some call the rebalancing bonus) was in that area.

In other words, say PME returned 5%, but if you owned PME and rebalanced then its addition had impact on the return of the portfolio as if it returned 10%. The only right way to look at things. I am sure if you search Bill's Efficient Frontier site you can find that article

The examples in my books in the commodity sections show similar results for CCF. Very large diversification return due to very low to negative correlation and the very high volatility.
User avatar
tetractys
Posts: 6249
Joined: Sat Mar 17, 2007 3:30 pm
Location: Along the Salish Sea

Re: TET

Post by tetractys »

larryswedroe wrote:need to be able to read more carefully---I said that Bill Bernstein found that the diversification return (what some call the rebalancing bonus) was in that area.

In other words, say PME returned 5%, but if you owned PME and rebalanced then its addition had impact on the return of the portfolio as if it returned 10%. The only right way to look at things. I am sure if you search Bill's Efficient Frontier site you can find that article

The examples in my books in the commodity sections show similar results for CCF. Very large diversification return due to very low to negative correlation and the very high volatility.
Well I read that. The article's to loose; the regression seems thrown together. It's more or less a sympathy piece toward precious metals funds, rather than a level look at a useful asset. (http://www.efficientfrontier.com/ef/197/preci197.htm)

I should check out your book again and review your numbers. The studies I've seen on CCF always show too narrow a band of MPT derived benefit, and too much uncertainty, in my mind, around even those results recurring with any dependability. If costs could be kept below say .25, it seems doable, but still iffy. -- Tet
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

from the book TET

Post by larryswedroe »

Consider the following results, covering the period from 1991 through 2007.
Portfolio Allocation Annualized Return Standard Deviation
100% DJ-AIG 7.91% 16.63%
100% GSCI 6.80% 25.62%
100% S&P 500 11.41% 17.00%
95% S&P 500/5% GSCI 11.42% 15.94%
95% S&P 500/5% DJ-AIG 11.39% 15.98%
There are two important observations. First, while both the DJ-AIGCI and the S&P GSCI underperformed the S&P 500 Index by large amounts, the addition of a 5 percent allocation to either resulted in a more efficient portfolio. Second, despite the DJ-AIGCI’s seeming advantages, the portfolio including the DJ-AIGCI produced a virtually identical return and volatility as did the portfolio that included the S&P GSCI. The reason is that when you have an asset with negative correlation, and you add a small allocation of it to the portfolio, high volatility is actually a good thing.

As you can see the addition of the GSCI impacted the portfolio as if it earned roughly the same 11.4% as did the S&P yet it only returned 6.8, so the diversification return for that period was 4.6%. Not quite as high for the less volatile DJ AIG.

Yes I would also like a cheaper fund, though DFA getting there, probably will be under 50bp before too long. The bigger issue is the contango in energy. So question relative to both costs and contango is how much are you willing to pay for "insurance"?

Remember this, say you add 5% CCF and pay DFAs 55bp, instead of say 40bp for a diversified equity portfolio. So you have 15bp more expense for the large diversification return. Can do the math for other funds and other AAs if you like.

Best
Larry
Wagnerjb
Posts: 7213
Joined: Mon Feb 19, 2007 7:44 pm
Location: Houston, Texas

Re: from the book TET

Post by Wagnerjb »

larryswedroe wrote:There are two important observations. First, while both the DJ-AIGCI and the S&P GSCI underperformed the S&P 500 Index by large amounts, the addition of a 5 percent allocation to either resulted in a more efficient portfolio. Second, despite the DJ-AIGCI’s seeming advantages, the portfolio including the DJ-AIGCI produced a virtually identical return and volatility as did the portfolio that included the S&P GSCI. The reason is that when you have an asset with negative correlation, and you add a small allocation of it to the portfolio, high volatility is actually a good thing.
Larry - the comparison is inappropriate. Nobody owns 100% S&P500. We all have fixed income and we all have international. A significant portion of the reduction in volatility (from owing the S&P500) can be achieved by adding regular bonds, TIPs and international (all at an ER of 0.10%).

Only after you have a well diversified portfolio should you look at sprinkling in CCFs. It is that incremental return and volatility component that should be compared with the additional ER that you pay.

Much of the volatility reduction that you demonstrate has already been achieved by most investors, without use of CCFs.

Best wishes.
Andy
Roy
Posts: 970
Joined: Wed Sep 10, 2008 9:34 am

Post by Roy »

Here Larry supplies data showing the effects of CCFs on portfolios that contain both stocks and bonds.

http://moneywatch.bnet.com/investing/bl ... ance/1612/

http://moneywatch.bnet.com/investing/bl ... ntent;col1

I think his "Alternative Investments" book also showed the effects with domestic and international equities.
Wagnerjb
Posts: 7213
Joined: Mon Feb 19, 2007 7:44 pm
Location: Houston, Texas

Post by Wagnerjb »

Roy wrote:Here Larry supplies data showing the effects of CCFs on portfolios that contain both stocks and bonds.

http://moneywatch.bnet.com/investing/bl ... ance/1612/

http://moneywatch.bnet.com/investing/bl ... ntent;col1

I think his "Alternative Investments" book also showed the effects with domestic and international equities.
Sorry, those are also unacceptable. Why no international stocks? Why no TIPs? We all have them. And why does Larry use the S&P500 as the only stock holding? How about Total Stock Market?

Surely, somebody has run the data to show what an incremental addition of CCFs do to a well-diversified portfolio.
Andy
grayfox
Posts: 5569
Joined: Sat Sep 15, 2007 4:30 am

Re: my commodity exposure is getting killed

Post by grayfox »

Roy
Posts: 970
Joined: Wed Sep 10, 2008 9:34 am

Post by Roy »

Wagnerjb wrote:
Roy wrote:Here Larry supplies data showing the effects of CCFs on portfolios that contain both stocks and bonds.

http://moneywatch.bnet.com/investing/bl ... ance/1612/

http://moneywatch.bnet.com/investing/bl ... ntent;col1

I think his "Alternative Investments" book also showed the effects with domestic and international equities.
Sorry, those are also unacceptable. Why no international stocks? Why no TIPs? We all have them. And why does Larry use the S&P500 as the only stock holding? How about Total Stock Market?

Surely, somebody has run the data to show what an incremental addition of CCFs do to a well-diversified portfolio.
You asked to see data that included stocks and bonds, and Larry has provided it. If you want to see how a particular CCF allocation affects your portfolio, run the comparative data yourself for your own portfolio.

There isn't much difference between TSM and the S&P so I would not expect to see much difference in the portfolio returns using TSM. The data that includes international is in the book, and, like domestic equity, international is held by investors in different types and weightings. That no TIPS are mentioned in these analyses is irrelevant for several reasons, especially since many do not include TIPS in their diversified portfolios, or they may be held in different weightings, and TIPS are available in varying maturities as are nominal bonds.

Taken altogether, the above may include different allocations to equities, bonds, and different sub-allocations among those classes, and all these may be combined to provide an almost infinite number of portfolios. The only thing that matters is how an addition impacts your personal portfolio as a whole. This is why each investor must decide on the suitability of these as it applies to their own particular portfolios.

The examples Larry provided were interesting because he showed how a highly-volatile asset class (in isolation) can improve a portfolio's performance even when the returns of that asset class (in isolation) were not very good. This is the essence of viewing a portfolio as whole. Whether one wants to include CCFs or not is another question, but the analysis must include how they impact an investor's particular portfolio.
phositadc
Posts: 443
Joined: Mon Jul 26, 2010 6:17 pm

Re: my commodity exposure is getting killed

Post by phositadc »

He may have lost 7% in 2 days, but he has also probably gained most of it back by now.

And to respond to wagner, use Simba's spreadsheet to add a 5% commodities holding to any asset allocation you desire. I'll do it for you for one instance.

20% TSM, 10% SCV, 5% REIT (total = 35% domestic equity), 20% Total Int'l, 10% Emerging Mkts, 5% Intl Small (total = 35% int'l equity), 15% TIPS, 15% TBM.

From 1972-2010: CAGR = 11.77%, Std Dev = 14.24%.

If we reduce the 20% Total Int'l to 15% and add 5% to CCFs, you get:

CAGR = 11.81%, Std Dev = 13.36.

If you don't believe me, download Simba's spreadsheet and try it with any asset allocation that you like.

Point being, as larry has tried to make, adding a small exposure to CCFs to almost ANY well-diversified portfolio, will---in the long run---reduce volatility while maintaining (or even slightly increasing) expected returns.

I fully agree with you that, taken in isolation, CCFs are a poor investment. But whether you like it or not, over the past 40 years a small CCF exposure to pretty much any well-diversified portfolio has been beneficial.

Will it remain beneficial for the next 40 years? Who knows. Will stocks continue to provide reliable 7% average annual returns for the next 40 years? Who knows.
matt
Posts: 2305
Joined: Sun Mar 04, 2007 2:47 pm

Re: my commodity exposure is getting killed

Post by matt »

chrikenn wrote:Point being, as larry has tried to make, adding a small exposure to CCFs to almost ANY well-diversified portfolio, will---in the long run---reduce volatility while maintaining (or even slightly increasing) expected returns.
Correction: Adding a small exposure to CCFs to almost ANY well-diversified portfolio would have--in the past--reduced volatility while maintaining (or even slightly increasing) expected returns.

The trouble is that many commodity futures have been in persistent contango for the past 5-6 years, when more investment options became available and everyone caught on to the incredible diversification impact on back-tested portfolios. Occasional contango is not unusual and doesn't imply a problem, but persistent contango across almost all commodities implies persistent overvaluation. In other words, CCF investors today are paying a large premium for the diversification benefit. Alas, that large premium serves to eliminate most of the diversification benefit because expected returns are substantially lower than historical returns. Thus, I think investors using CCFs should have no more than 5% allocated to this position as there is a decent chance that they would have been better off with 0% going forward (which is the only time frame that matters).
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

Andy

Post by larryswedroe »

Have to laugh.

First you say that no one owns 100% equities. That of course is simply false statement. There are plenty of people who do and many who have more than 100% equity when do the math right (taking their mortgage as negative fixed income). Not small percent but large number. Also many people don't own any international

Second, it is just example, meant as illustration. You can run the math at all kinds of levels. Do you want me to run it at every AA every time someone asks about well that is okay at 60/40 but what about 40/60?

Third, the outcomes show large diversification returns at the various AAs I have looked at. In fact the standard one we show clients/prospects is 60/40 with 40% international.

Fourth, yes once you add many asset classes the benefits of adding another become less, but they don't go away.

The example we show using a globally diversified portfolio covering 70-09 taking 4% from equities and using GSCI shows portfolio return dropped from 11.09 to 11.04 but volatility dropped from 13.09 to 12.2 and Sharpe Ratio increased from .465 to .486.

Hopefully that meets YOUR criteria of a good example

Best wishes
Larry
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

Matt

Post by larryswedroe »

First I completely agree the world has changed. How it will look in future we don't know either. Just as valuations matter with stocks, contango or backwardation matters with CCF. We do know it is likely we will see low to negative correlations and high volatility, leading to high diversification returns if rebalance. What we don't know is if the benefit will be enough to cover the costs. Or whether you will get a big benefit as have in the past.

Second, I have always recommended only a small allocation as much is not needed due to the low/negative correlation and high volatility, and also the issue above. So typically saying 5-10% of equity. And the less equity and the shorter the duration of your nominal bonds, the less CCF one needs.

I don't know the answer but I would be surprised if any of our clients has more than a 5% CCF allocation and the more typical is 2-3%. And part of that is due to we don't tend to own LT nominal bonds and we emphasize TIPS also. But we do believe investors should consider CCF inclusion, and the more risk averse one is to geopolitical events and unexpected inflation the more they should consider CCF.

Best
Larry
phositadc
Posts: 443
Joined: Mon Jul 26, 2010 6:17 pm

Re: my commodity exposure is getting killed

Post by phositadc »

matt wrote: Correction: Adding a small exposure to CCFs to almost ANY well-diversified portfolio would have--in the past--reduced volatility while maintaining (or even slightly increasing) expected returns.
You are right -- I can't argue with that. But I did kind of cover that in my last paragraph where I acknowledge we don't know if the benefits will continue over the next 40 year period :wink: I---for one---think that they will, if perhaps not to the same extent as in the past.
rkayakr
Posts: 49
Joined: Sun Mar 21, 2010 9:47 am
Contact:

Post by rkayakr »

Scott S

"I can't remember who said it first, but being diversified means you're always unhappy with something in your portfolio.

- Scott"

I think that you have it backward. Being diversified means that you are always happy about something in your portfolio.

I have had a small allocation of PCRIX for the last year. It has had a total returned of about 30%. I have had to take funds out to maintain my target allocation. Remember that in addition to NAV change, PCRIX has returned an average annualized dividend of 10.3% over the last 5 quarters. On the 17th they issued a $0.2478 divided per share (about 9.9% annualized), so share price dropped accordingly.

RE comments an the past not being a good predictor for the future. Isn't that true for ALL investments?
Last edited by rkayakr on Fri Mar 18, 2011 9:54 am, edited 1 time in total.
With many cheerful facts about the square of the hypotenuse | - Modern Portfolio General, Gilbert & Sullivan
Roy
Posts: 970
Joined: Wed Sep 10, 2008 9:34 am

Re: my commodity exposure is getting killed

Post by Roy »

chrikenn wrote:
matt wrote: Correction: Adding a small exposure to CCFs to almost ANY well-diversified portfolio would have--in the past--reduced volatility while maintaining (or even slightly increasing) expected returns.
You are right -- I can't argue with that. But I did kind of cover that in my last paragraph where I acknowledge we don't know if the benefits will continue over the next 40 year period :wink: I---for one---think that they will, if perhaps not to the same extent as in the past.
Some would raise similar forward-looking questions regarding the equity risk premium (from today's valuations compared to historical) and bonds (based on today's yields compared to the last few decades). While the deep future may differ from the deep past, it does not mean historical data can not help inform present decisions.
User avatar
bob90245
Posts: 6511
Joined: Mon Feb 19, 2007 7:51 pm

Post by bob90245 »

rkayakr wrote:RE comments an the past not being a good predictor for the future. Isn't that true for ALL investments?
It's more than that. We can largely predict long-term equity and bond returns based on current fundamental factors. Current interest rates low? Future bond returns are likely to be low. Current stock valuations high? Future stock returns are likely to be low.

The same analysis cannot be performed with CCFs. If there were a metric that can tell us whether CCFs will be in backwardation or contago, that would go a long way from removing it from being merely a speculative asset and placing it into the prudent investment category.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.
rkayakr
Posts: 49
Joined: Sun Mar 21, 2010 9:47 am
Contact:

Post by rkayakr »

bob90245

Hmmm - your comments seem to be in variance with your tag line. Do you change your asset allocations based on current interest rates or current equity valuations? How often to you change your allocation plan versus rebalancing to that plan?

These are genuine questions about issues that I struggle with.
With many cheerful facts about the square of the hypotenuse | - Modern Portfolio General, Gilbert & Sullivan
User avatar
bob90245
Posts: 6511
Joined: Mon Feb 19, 2007 7:51 pm

Post by bob90245 »

rkayakr wrote:bob90245

Hmmm - your comments seem to be in variance with your tag line. Do you change your asset allocations based on current interest rates or current equity valuations? How often to you change your allocation plan versus rebalancing to that plan?

These are genuine questions about issues that I struggle with.
It's only a struggle if you believe you have the ability to outperform by timing the markets. Give up the hope of outperformance by simply accepting what the markets offer you.

The flip side is that if the stock market moves from low valuations to high valuations, your now-larger portfolio brings you much closer to reaching your goals. Thus, you can revisit your equity-fixed mix and decide that the need to take equity risk is lower. Therefore, it may be prudent to lower your stock allocation and ease into reaching your goal. In other words, as Larry has often said, if you have already won the game, you can choose not to play.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.
rkayakr
Posts: 49
Joined: Sun Mar 21, 2010 9:47 am
Contact:

Post by rkayakr »

bob90245

Well I certainly have not won the game.

"It's only a struggle if you believe you have the ability to outperform by timing the markets. Give up the hope of outperformance by simply accepting what the markets offer you."

EXACTLY! I try to stick to my allocation plan whether I think in the future interest rates might rise, equity evaluations might fall or CCFs have contango. I don't see how acting on some analysis predictions is "prudent" and others "speculative" as you indicated in your post.
With many cheerful facts about the square of the hypotenuse | - Modern Portfolio General, Gilbert & Sullivan
User avatar
Scott S
Posts: 1937
Joined: Mon Nov 24, 2008 2:28 am
Location: building my position

Post by Scott S »

rkayakr wrote:Scott S

"I can't remember who said it first, but being diversified means you're always unhappy with something in your portfolio.

- Scott"

I think that you have it backward. Being diversified means that you are always happy about something in your portfolio.

I have had a small allocation of PCRIX for the last year. It has had a total returned of about 30%. I have had to take funds out to maintain my target allocation. Remember that in addition to NAV change, PCRIX has returned an average annualized dividend of 10.3% over the last 5 quarters. On the 17th they issued a $0.2478 divided per share (about 9.9% annualized), so share price dropped accordingly.
Both statements can (and should!) be true at the same time. :wink:

The point of Bernstein's quote is to reassure the person who sees a "loser" in their portfolio that they should stay diversified, and not attempt to invest just in things that are "winning" now.

- Scott
"Old value investors never die, they just get their fix from rebalancing." -- vineviz
User avatar
bob90245
Posts: 6511
Joined: Mon Feb 19, 2007 7:51 pm

Post by bob90245 »

rkayakr wrote:bob90245

Well I certainly have not won the game.

"It's only a struggle if you believe you have the ability to outperform by timing the markets. Give up the hope of outperformance by simply accepting what the markets offer you."

EXACTLY! I try to stick to my allocation plan whether I think in the future interest rates might rise, equity evaluations might fall or CCFs have contango. I don't see how acting on some analysis predictions is "prudent" and others "speculative" as you indicated in your post.
If my evaluation of stock valuations indicate a mininal long-term equity risk premium was likely, that might cause me to revisit my asset allocation plan. This would be an exception because, for the most part, the equity risk premium has been sufficient to be rewarding.

In the case of CCFs, there is no fundamental metric that tells you the equivalent of a long-term "equity risk premium". If no fundamental metric exists that holding CCFs will be more rewarding than holding bonds, I consider this to be a speculation.

Now Larry might counter that a proper analysis does not look at assets in isolation, but rather how they interact with the other assets in your portfolio. Unfortunately, the long-term data used for this analysis is only on paper when backwardation was the rule, not using real money with real costs. However, the recent data with real money shows that investors have encountered contango.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.
Wagnerjb
Posts: 7213
Joined: Mon Feb 19, 2007 7:44 pm
Location: Houston, Texas

Post by Wagnerjb »

Roy wrote:You asked to see data that included stocks and bonds, and Larry has provided it. If you want to see how a particular CCF allocation affects your portfolio, run the comparative data yourself for your own portfolio.
The two Moneywatch articles that you linked show a 60/40 portfolio of US equities and regular bonds. Looking at the longer term data in both articles (generally around 10 years) shows that adding CCFs to these moderately diversified portfolios does little to reduce volatility. The benefit to the Sharpe Ratio is coming from the higher return of the combined portfolio.

I don't need this data to make a decision since I don't need any extra commodity exposure as an energy industry employee. But others considering CCFs should assume only a negligible benefit on the volatility side from adding CCFs to a portfolio with US and international equities plus regular and inflation bonds.

Matt has raised excellent points about the future of CCF returns since the commodity futures market have fundamentally changed with regular investors now playing that market. We are already seeing the effects of the investor influx with the more persistent contango in oil futures, so informed investors needs to take this potential into account.

So you have to question the volatility reduction. And you have to question the recent high returns. IMO, the case for CCFs rests on a rebalancing benefit. And I wonder if paying 0.75% is too much for that benefit.

Just my opinion....
Andy
matt
Posts: 2305
Joined: Sun Mar 04, 2007 2:47 pm

Post by matt »

bob90245 wrote:It's more than that. We can largely predict long-term equity and bond returns based on current fundamental factors. Current interest rates low? Future bond returns are likely to be low. Current stock valuations high? Future stock returns are likely to be low.

The same analysis cannot be performed with CCFs. If there were a metric that can tell us whether CCFs will be in backwardation or contago, that would go a long way from removing it from being merely a speculative asset and placing it into the prudent investment category.
This gets to another point about CCFs. It's next to impossible to generate a long-run expected return because that return is highly dependent on the unpredictable nature of the futures curve. If you assume current contango levels will maintain in the future, CCF "valuations" are high and thus expected returns are low. At current valuation levels, equity returns are also low. However, there is a big potential difference in how to end up with high expected returns. With stocks, there is only one near-term option: stock prices must decline significantly. With CCFs, there are two near-term options: commodity prices could decline significantly OR futures contango could be replaced with backwardation. In theory, the futures shift could occur over a very short period of time with minimal losses to CCF holders and yet result in a meaningful rise in expected returns. That is because the futures need to be continually rolled over every 1-2 months, which means that you are only locking in the premium or discount to spot for a short period of time, not indefinitely like you are locking into a stock's valuation. In other words, the futures component of CCFs has a very low duration, while stocks have a very high duration.

So is there anything actionable about this? Not much! But it points out that buying CCFs today is not guaranteed to produce low returns just because current conditions are unfavorable. It's possible future conditions will be better...but they could also be worse, I suppose. It may take a long time, but my guess is that if CCFs produce poor returns over a long period of time, which is likely, some investors will exit this asset class and backwardation may one day return. At that point, a commitment to CCFs would be more attractive.
rkayakr
Posts: 49
Joined: Sun Mar 21, 2010 9:47 am
Contact:

Post by rkayakr »

bob90245 wrote:

"However, the recent data with real money shows that investors have encountered contango."

PCRIX
1 month + 2.4%
3 month + 8.6%
1 yr +29.8%

If "contango" means a 30% return over the recent year with my real money, as PCRIX has delivered, I'll take it. I just don't see poor recent performance.

Wagnerjb

I think that band rebalancing, rather than fixed time rebalancing, is useful for volatile instruments like CCFs.
With many cheerful facts about the square of the hypotenuse | - Modern Portfolio General, Gilbert & Sullivan
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

rkayakr

Post by larryswedroe »

Band rebalancing, not time, is the only kind IMO that makes sense. And the more volatile the asset the wider the band should be (in presence of costs and taxes)
Post Reply