Commodities give balance
NEW YORK – If you own both stock and bond funds, you probably consider yourself well-diversified. But research by Lipper Inc. suggests broad exposure to commodities like gold, oil and copper can go a long way toward rounding out a mutual fund portfolio, as long as you understand the risks.
One of the reasons stocks and bonds are paired together is that they can perform differently from each other – when one declines, the other typically advances. For even more diversification, professional investors often add other asset classes, such as real estate and commodities, that theoretically can zig when stocks or bonds zag.
“When the stock market drops, you don’t necessarily notice it at the gas pump,” said Patricia Jennerjohn, head of Focused Finances in Oakland, Calif. “The price of oil will drive the market as far as sentiment goes, but it’s not necessarily correlated in terms of performance.”
Mutual funds and exchange-traded funds that invest in commodities and real estate investment trusts have made it possible to use these alternative investments even in very small portfolios. For commodities in particular, there’s a wide array of products, from funds that invest only in gold or natural resources to all-inclusive indexes that hold everything from crude to cotton.
“Commodities are clearly a separate asset class and would be a good diversification addition to an investor’s portfolio,” said Andrew Clark, a senior research analyst at Lipper. “They’re on a very strong ride up, so you may want to be overweighted in them more than you might have been in the late ‘90s.”
For small investors looking for an edge but not a roller coaster ride, a broadly diversified commodities index is probably best. Natural resources funds do not provide any real diversification because they are highly correlated with both large-cap and small-cap stock funds, Clark said. And while gold offers diversification, it comes with a high degree of volatility and twice the risk of small-cap stocks.
There’s a growing number of broad commodity funds to choose from. PIMCO Commodity RealReturn Strategy (PCRDX) uses derivatives that mimic the Dow Jones-AIG Commodity Index and invests the remainder of the portfolio in bonds, such as Treasury Inflation Protected Securities. The Oppenheimer Real Asset fund (QRAAX) tracks the Goldman Sachs Commodities Index, as do the Merrill Lynch Real Investment fund (MDCDX), introduced last year, and the just-launched Rydex Commodities Fund (RYMBX).
The most important difference between these funds is how their underlying indexes are structured. The DJ-AIG Commodity Index limits exposure to the various asset classes; for example, energy exposure is capped at 33 percent. The GSCI’s weightings are changeable, with energy currently accounting for more than 73 percent; for this reason, it carries substantially more risk.
The main thing to keep in mind when selecting investments is your own time horizon and appetite for risk, said Jennerjohn. If you want to invest in commodities but don’t like seeing your nest egg jostled, the PIMCO fund is probably good option, she said. You should also have reasonable expectations about how your various holdings are performing.
“A good portfolio will always have a couple of things that are misbehaving,” Jennerjohn said. “If everything is going up all at once I get kind of nervous. In the long run everything should work well together.”