The Problem with Passively Managed Commodity Funds
Dear Clients.
Last week, I liquidated your entire position in PIMCO Commodity Real Return Strategy Fund (Ticker symbol PCRDX or PCRAX) which represented approximately 10% of your overall portfolios. PCRDX is a mutual fund that is intended to mirror the Dow Jones-AIG Commodity Total Return Index which is an unmanaged index comprised of 19 physical commodities. In case you’re interested, here are the approximate weightings of the commodities in the index.
Natural Gas 12.28%
Crude Oil 12.81%
Unleaded Gas 4.05%
Heating Oil 3.85%
Sugar 2.93%
Wheat 4.87%
Cotton 3.23%
Corn 5.94%
Coffee 3.02%
Soybeans 7.60%
Soybean Oil 2.67%
Aluminum 7.06
Copper 5.89%
Zinc 2.67%
Nickel 2.61%
Gold 5.98%
Silver 2.00%
Live Cattle 6.15%
Lean Hogs 4.39%
Here’s my rationale for selling the fund. First of all, I was on the right track in 2003 when I began to build positions in commodity funds to take advantage of what has obviously evolved into a structural bull market in commodities. The PIMCO fund has served is purpose in allowing us access to a broad basket of commodities. However, the disadvantage of these long-only “passive” index funds is that they maintain the same weightings without regard for the fundamental outlook of each commodity underlying the index. Holding a predetermined percentage of a commodity with poor supply/demand characteristics can exert significant drag on the overall fund’s performance. This is exactly what happened to PCRDX in 2006, and it’s the primary reason I’m disenchanted with passively managed commodity funds. Another reason is that there are alternatives available today that will enable me to manage more “actively.”
Innovative new products have been developed to help financial advisors and investment managers focus on certain opportunities without having to carry the baggage of entire indexes. After all, this is the era of Exchange Trade Funds (ETF). New ETFs may become so refined they can be used surgically on a portfolio. I intend to use these tools at Catamount until I devise another method, of which I’m diligently pursuing. I’m sure the solution will incorporate a long-short strategy along with an element of active portfolio management. There will be more on that subject in the future.
With all of this talk about commodities, I will leave you with a brief outlook on various commodities in 2007. I expect downward pressure on industrial metals prices (i.e. copper, zinc, nickel, aluminum) as the U.S. economy decelerates. As I have intimated in a previous writing, I’m very constructive on precious metals (i.e. gold and silver) because I believe the U.S. Dollar will continue to slide against other currencies and I suspect inflation pressures will mount. Finally, after a serious correction in energy prices, I’m bullish on oil and gas once again.
Greg
