TODAY
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
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.”
F 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.
Okay?
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?”
F 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?”
F 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)?”
F 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.”
F 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.”
F 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.”
F 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?”
F 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.