By Murray Coleman
The use of commodities funds holding everything from oil to gold has become increasingly popular as a broad investment tool, even as more portfolio managers have started to question how effective this will be over time.
Conventional wisdom maintains that holding large baskets of commodities can provide investors with a good hedge against inflation as well as low correlations to equities.
But lately, funds investing across all types of such assets have been moving closer in-step with the S&P 500 index, notes Ned Davis Research strategist Neil Leeson.
For example, returns of the iShares S&P GSCI Commodity Index Trust (GSG) have been trading in the past two years with a 0.71% correlation to the SPDR S&P 500 ETF (SPY). To put that into perspective, Mr. Leeson estimates that such a level--with 1.0 representing perfect tandem--is roughly five times higher than its benchmark's average going back to 1980.
His research also suggests that during more recent cycles of heightened inflation risks, broad commodities funds are proving less effective as inflation fighters than those focused on staid Treasury Inflation-Protected Securities.
"Easy access through exchange-traded funds is helping to make commodities more a part of the "risk-on" trade than they've traditionally been," he says.
Perhaps that trend will eventually ease with commodities decoupling from equities. Until they do, "commodities likely won't be as good a way to strategically invest as TIPS for inflation and non-correlated protection," Mr. Leeson says.
While benign at the moment, "it's hard to imagine that inflationary pressures won't be more of a factor in the future," says Bryan Stephens, an adviser at UBS Financial Services in New York who manages $250 million in assets.
As a result, Mr. Stephens holds the iShares Barclays Treasury Inflation Protected Securities Bond Fund (TIP). "In futures markets, swaps are being traded as if inflation is a non-issue even going out 10 years," he says. "I don't necessarily agree with that view. We feel that it's better to buy insurance now when expectations for inflation are low."
Commodities are also a part of his asset allocation plan, although Mr. Stephens is largely investing in stock funds that stand to benefit from improving economic conditions. Those include the Vanguard Energy ETF (VDE) and the Market Vectors Agribusiness ETF (MOO), as well as broader-based funds.
"Funds investing in commodities futures can be ravaged by rising prices as they roll expiring contracts over month-to-month," Mr. Stephens says. "We find it simpler and more effective to buy companies that can leverage different parts of their operations to generate greater profits."
Vanguard Group strategists are telling advisers and institutional portfolio managers much the same, pointing to data showing a doubling in correlations between commodities and domestic stock benchmarks from 2001-2009 compared to 50-year averages.
While it's still too soon to tell if market characteristics have changed for good, Daniel Wallick of the fund giant's investment strategy group believes long-term investors are likely to be best served by diversifying across stock funds.
"When you're looking at TIPS funds, it's typically the shorter-term, unexpected spike in prices that they're most effective guarding against," he says. "In terms of a reasonable long-term inflation hedge, we still like broad exposure to equities, more so than to commodities."
Murray Coleman is a Dow Jones columnist who writes about personal finance; he covers topics including exchange-traded funds and mutual funds. His columns are available to Dow Jones subscribers.
