Notice, of course, that President Bush is rolling David Petraeus out [the week of] Sept. 11 – because, one more time, he’ll try to make the case that Iraq is somehow tied to 9/11. It’s a phony argument, but one that Petraeus, apparently, is more than willing to help him make.* – Bill Press
Borealis subsidiary Chorus Motors subsidiary WheelTug – you know, the one we hope will have pilots driving their 767s around the tarmac like golf carts – announced yesterday an important step in the process of getting certified by December, 2009. There is no assurance any of this will happen, of course, let alone within the hoped for timeframe. But it’s nice to see this news picked up in the Wall Street Journal On-Line. And my guess is that Newport Aeronautical would not be taking on this assignment expecting to fail.
Patience, Jackasss – patience. (And here, by ‘Jackass,’ I am of course referring to myself.)
THE SUBPRIME MESS
Jonathan Edwards: ‘You write: ‘Smart people at high levels of the Administration …. are working for the softest possible landing.’ That poor guy is terribly overworked. No wonder things are going to hell in a hand basket.’
☞ Point taken.
(His name is Hank Paulson! But I also said ‘and Congress,’ which would include, for example, Financial Services Committee Chair Barney Frank.)
COMMODITY FUNDS TO STRENGTHEN YOUR RETIREMENT PORTFOLIO?
Do not feel you need to read every word that follows. The very short summary is that (in my view) it would be perfectly reasonable to put 20% of your retirement fund into PCRIX as Less advocates (or PCRDX if you can’t make the $25,000 minimum). I also think – and Less will kill me for this – it’s not the worst time to have some of your retirement fund earning 5% or so in cash.
Here we go.
Paul Ward: ‘Less Antman is advising people over 50 to put 20% or so of their retirement savings into commodity future mutual funds. He apparently has about 30% of his own portfolio in such funds. As I understand it, he views this as an effective way to diversify a portfolio against stock market risk. What do you think?’
☞ I think Less is a very smart guy. That said (and as he would acknowledge), in a depression, both stocks and commodities would fall terribly (where the value of government bonds would rise) . . . so that is one chink to be aware of. (Less notes that commodity futures funds, which is what he’s recommending, might not fare as badly as commodities themselves).
There may be other chinks, but as you will see, Less is unfazed by the skeptics.
For example, several of you cited this persuasive article by Bill Bernstein, the nub of which is that some of the underlying factors that made Less’s strategy a good one in the past are no longer valid.
☞ Less responds: ‘I read Bill Bernstein’s piece when it came out last year. Since it is long, it deserves a long response, which I have provided here. The short version is that the case for commodity futures rests on their low correlation to stocks (and bonds and REITs). Even if everything Bernstein wrote in that piece about future returns were true, this case hasn’t been weakened in the slightest, and unleveraged, diversified commodity futures are still worth considering by anyone interested in reducing the risk of their overall portfolio by applying the insights of Modern Portfolio Theory. Note, too, that Roger Ibbotson, Bill Gross, Rob Arnott, Mark Kritzman, and Roger Gibson are on my side of this argument. I have very good teammates in this contest.’
Mike Albert: ‘Less Antman’s argument looked really good to me (I’d considered diversifying with commodities before) until I looked at the 1.24% expense ratio of the PIMCO Commodity Real Return Fund (PCRDX) Less favors. For a Vanguard lover who expects index fund expenses of a few tenths of a percent, that’s a deal breaker. A bit of Googling reveals that the iPath® Dow Jones-AIG Commodity Index Total Return ETN (symbol: DJP) tracks the same index Less likes. However I’m not sure how an ETN differs from an ETF, and the computation of the fund’s annual fee is (to me) incomprehensible. Do you have any thoughts on this or other less expensive alternatives?”
☞ Less responds: “The PIMCO Commodity Real Return Institutional Fund (PCRIX) has a 0.74% expense ratio, and is available through Vanguard with an account minimum of $25,000. Furthermore, since it uses TIPS instead of T-Bills as collateral, it should earn an extra 1.5% or more per year, on average, making its expense ratio, in comparison to the Dow Jones AIG Commodity Index itself, negative. Even PCRDX, for those who cannot meet the high minimum of PCRIX, has an effective negative expense ratio once you take into account the use of the higher return TIPS (which also make it more of a hedge against unexpected inflation, and may lower the correlation of PIMCO’s funds to stocks even more than the regular index!).
“DJP is an Exchange Traded Note issued by Barclays Bank. It pays a return based on the performance of the Dow Jones AIG Commodity Index, with T-Bills as the assumed collateral, so that I expect its net return to be worse than either PIMCO fund. That isn’t my main concern, though. If you purchase that note, you are not investing in commodity futures: you merely have an unsecured note from Barclays in which they promise to pay an amount equal to what the index return would provide . . . and if Barclays should have financial trouble, you could lose your investment regardless of the performance of the index. While Barclays is a reasonably secure AA-rated company, this is an undiversified risk I’m not willing to take myself or suggest for others.
“For those who want to use ETFs, they might consider the all-ETF portfolio that I use for my own personal commodity investments, and whose running results are posted on my wiki. I put one-third into DBA, one-third into DBE, one-sixth into DBB, and one-sixth into DBP. This produces a similar category allocation to a PIMCO fund, with a couple of key advantages: (1) it doesn’t automatically choose the nearest contract, but the lowest price contract, which reduces the ‘contango’ problem Bill Bernstein harps on, and (2) it doesn’t contain any animal futures contracts, which makes this vegan Taoist very happy. A disadvantage is that it uses the traditional T-Bill collateral, so the TIPS bump isn’t there; but the weighted average expense ratio of this option is only 0.8%. By the way, DBC is not an acceptable all-commodity substitute, as it only contains 6 commodities, and is weighted far too heavily toward energy futures. GSG is even worse.”
Jonathan Edwards: “I wonder why Less Antman prefers PCRDX (expense ratio 1.24%-1.99%, plus a load as high as 5.5%, depending on the class of shares) to DJP (annual fee 0.75% of account value, as near as I can tell)?”
☞ Less responds: Already answered. Naturally, I would only use the no-load versions of PCRIX and PCRDX.
David Maymudes: “Do you have 30% or even 10% in commodity futures funds? [Me? No. I’m mainly in mud. – A.T.] I still don’t understand what they are. My impression from what Less has said is that these mutual funds are 95% invested in TIPS, and then take the remaining 5% and buy commodity futures. Then, they charge a close-to-2% fee on the whole bundle . . . so it seems like you’re paying 0.5% fees for the TIPS and close to 30% fees to play the commodities market (treating the extra 1.5% mutual fund fees relative to the 5% that’s really in commodities.) I understand in principle the benefits of non-correlated assets, but these funds look pretty scary to me. I asked Less about this issue on his message board [last item on the page] and didn’t get much of an answer.”
☞ Less responds: “I basically agreed with David. I look forward to competitive pressures bringing down the fees over time (Vanguard: where are you when we need you?).”
Jacob Roberts: “I really don’t like it when comparisons of portfolio performance are made over only one time period. Comparing relative returns over just the 1972-present time frame is going to include the worst bout of inflation in our nation’s history, and I doubt that this is particularly representative of the next 30 years. While I actually agree with the main thesis of the article you published (no reason not to diversify into commodity futures and they should be somewhat negatively correlated with stocks), this is a bone I have to pick with anyone who makes these types of comparisons. Further, the difference is somewhat thin between the stock/bond and stock/commodity investment strategies and while this makes a tremendous difference over a long time it also means that small changes in the nature of the markets could reverse the positions of the relative returns (or more likely result in more comparable returns with higher volatility in either one of the components). Also, the bond component used in the example is not particularly realistic. Short-term treasuries are the true riskless rate of return, and by adding a bit more risk in the bond portion of the portfolio via taking on longer durations, the relative results could have been significantly different. I would prefer to see a comparison between a weighted bond portfolio and commodities over the same time span and better yet, over numerous time spans. Also, there are TIPS now and there weren’t in the 70s and so a structured bond portfolio could look pretty different today as compared to then. Obviously, these things touch a nerve with me. Have a good day.”
☞ Less responds: “As the piece by Bill Bernstein indicates, there are other studies going back to the 1950s, and the stock market was so sanguine from 1942 to the start of my data period that I don’t expect to find any worse results (except possibly for the stock-bond allocation during the late 1960s). I made reference to studies that go back to the 1950s in my original piece, and while raw data is hard to find for free on the Internet, there is a solid piece here. There aren’t any formal studies going back longer, and I share the reader’s desire for more data: since commodity futures are more than a century old, these should be forthcoming, and any conclusion must be open to the possibility that other data will contradict the findings. I already noted in my piece that the Great Depression would probably have been bad for commodity futures, although I don’t know for sure, since commodity futures and commodity prices are not the same thing, and it is possible that heavy discounts from expected prices might even have resulted in positive returns in the early 1930s. It frustrates me not to have that data. I tried switching to longer bonds: the worst-case scenario was even worse, and I thought people would accuse me of an unfair comparison, as I was discussing safety, and most people would expect that short-term Treasuries are the safest. The return using the Lehman Bond Index was still lower than stocks/commodity futures. I agree with the reader about TIPS, but a long-term comparison utilizing them was impossible. Click here for more on my choice of time period.”
Michael Fang: “My…where to begin. What Mr. Antman is suggested is decidedly HARMFUL to your readers. I hope NO ONE follows his advice. Let me start by saying that at this late stage in the economic cycle, it is extremely STUPID to get into a commodity fund. But let’s leave aside this timing question for now. Let’s address the issue of the ‘studies’ that Mr. Antman referred to that purportedly show seemingly ‘free lunch’ diversification benefits. First, those studies were done in a period when NOBODY bothered to invest in commodities as an asset class. Because of that, plenty of commodities exhibited backwardization properties, meaning that the price of the longer expiration futures contracts are lower than the near term expiration futures contract for a given commodity. This means that if you buy the more distant contract, and even if the underlying commodity price doesn’t change, you will enjoy a ‘roll yield’ as the contract’s term becomes shorter. The problem is that ‘investing in commodities’ is now widely known among the insitutional investors. As a result, backwardization has disappeared for a lot of the commodities contracts simply because of the torrent of institutional money that went long these contracts. In fact, the more common phenomenon is contango, meaning the distant expiry contract’s price is higher than the near-term contract price. This means you now have a ‘drag’ or a negative roll yield. Second, A big part of the futures’ index total return comes from the interest you earn on the full margin you post if you don’t use any leverage. When the studies were done using histories in the 70’s, 80’s and 90s, interest rates were relatively high vs. now. That is obviously GONE in the context of the current environment. I don’t want to turn this into a treatise, but suffice to say, for an investor buying into commodity futures as an asset class as a diversification play, he may be sorely disappointed. BTW, the negative correlation between commodities and stocks and bonds have gradually disappeared in this decade because of hedge fund participation. Do your readers a favor and at least post this other point of view. You want diversification and a contrarian play? How about CASH? Cash is such a neglected asset class, and until the last month, was actually referred to as ‘trash’ (‘cash is trash’). But when every else is declining in value, CASH’s purchasing power actually increases. It is the perfect asset to hold in a deflationary environment.”
☞ Less responds: “I addressed Bernstein’s return arguments in the long version on my board. As for correlations rising between commodities and stocks/bonds, I would appreciate some evidence. As I indicated, there hasn’t been a 3-year period in which both the equal weight S&P 500 and the Dow Jones AIG Index dropped since at least the early 1930s. That includes the past decade. The argument that NOBODY ever treated commodity futures as an asset class until recently is, shall I say, rather extreme. Major textbooks on allocation have been addressing them for decades, commodity futures were popular enough for you to start your 1978 version of the ONLY INVESTMENT GUIDE YOU’LL EVER NEED with a discussion of them, the gold bug movement was indicative of a popular love of commodities in the 1970s, wealthy investors in hedge funds have been trading them for ages, and, once again, none of that affects the correlation argument. The argument for commodity futures is NOT that now happens to be a particularly good time to invest in them. I have no crystal ball, and I’m not as smart as those people who know exactly when an asset class is about to go up or about to go down: that’s why I diversify as widely as possible. All the time.”
Frank Walker: “I have been diversified into commodities – mostly timber – for a number of years. It has treated me well. I didn’t understand Mr. Antman’s remark at the end of his piece that ‘any allocation less than 10% means taking an unnecessary risk.’ Is that because too much remains committed to other assets?”
☞ Exactly. But note also that his strategy is not the same as buying commodities themselves (you bought a forest?) or buying stock in the companies that own commodities (PCL?).
Look at you! You actually read all the way to the bottom. You are intrepid. A deep bow to you. May good fortune follow you all your days, like a piece of particularly juicy piece of gossip.
* . . . [S]ix weeks before the 2004 election, when Bush was in a tight race for re-election against John Kerry, Petraeus wrote an op-ed citing ‘tangible evidence’ that American troops were making significant progress on the ground in Iraq.
Quote of the Day
If I had thought about it, I wouldn't have done the experiment. The literature was full of examples that said you can't do this.~Spencer Silver on the work that led to the unique adhesives for 3M Post-It Notepads.
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