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Jerry Miccolis is a senior advisor and co-owner of Brinton Eaton Wealth Advisors, which is based in Madison, N.J. The 20-year-old firm manages portfolios for institutions and high net worth investors. Its dedicated research staff tracks developments in bonds, stocks, mutual funds and exchange-traded funds. In commodities, Brinton Eaton focuses on mutual funds and exchange-traded notes. Before joining Brinton Eaton in 2003, Miccolis served as the global risk management practice leader at Towers Perrin. (HAI): Are you reducing positions in commodities at this point?

Jerry Miccolis, Brinton Eaton Wealth Advisors [Miccolis]: We're shifting more than reducing. That means we're going from a long-only play to more of a managed futures play that can go long as well as short. For example, historically we'd been in a long-only ETN, the GSP. We'd also held positions in a mutual fund that tracked the same index - the QRAAX. Through our own research and modeling, we had taken anywhere from a 10-15% position in client portfolios in the S&P GSCI.

HAI: How did you change those positions?

Miccolis: This is a change, literally, as we speak. We made this decision earlier in the week to take about half of those positions and move them into a fund that tracks the commodities trends indicator. It's basically an index published by Standard & Poor's. We have, for over a year now, been investing in the diversified trends indicator published by S&P through a mutual fund, the Rydex Managed Futures Strategy [RYMFX].

A component of that indicator is the commodities trends indicator. We liked that better because it has performed better than the broader indicator over the last several years. That has especially been the case during the more recent turmoil in the market.

Two investment vehicles have come online this summer tracking the CTI. One is the ELEMENTS S&P CTI ETN (NYSEArca: LSC). The other is a mutual fund, the Direxion Commodity Trends Fund [DXCTX]. We've taken half of our previous positions in commodities and put those assets into DXCTX.

HAI: What are the major advantages with these funds?

Miccolis: The advantage of the CTI versus a pure long-only commodities index is that it tends to be much less volatile over time and returns are still quite high. LSC follows the very quantitative, rules-based algorithm that S&P now has the license to use. Basically, it allows the fund to go long or short on commodities futures. But it's all based on the formula. The index covers 16 different commodities and can go long or short in all of them. The exception is in short positions for Oil and Gas. If the formula says to short either of those two areas, then the fund will get out of it. But it won't actually take short positions. Both the mutual fund and the ETN are trying to track the index, not beat it.

HAI: Why would you pick one over the other?

Miccolis: There are pluses and minuses to both. The ETN is more tax efficient and has a lower expense ratio. Over time, it's also expected to have a lower tracking error than the mutual fund since it's a note. But the disadvantage is counterparty risk. It's backed by HSBC's U.S. subsidiary. The mutual fund is backed by the basket of futures and swaps that are underlying the mutual fund. So there's counterparty risk there too, but it's spread over more than one bank or entity.

HAI: Do you still see commodities as good diversification tools for long-term investors?

Miccolis: In normal times, commodities are great diversifiers. But since mid-September, everything has been moving in the same direction. We're eager for markets to return to some semblance of normal so commodities return to being the great performance diversifiers they once were. In the meantime, we're hedging our bets by splitting our holdings between long and short positions through this commodities indicator. But we do believe that over the longer term, the diversification benefits of commodities will return.

HAI: Have you been investing in Alternative Energy?

Miccolis: No; but it's on our radar. Oil dropping from $147 a barrel to $45 a barrel is bad news for development of Alternative Energy sources. We're expecting a slowdown in funding, a slowdown in research and development in those areas. Until the fundamental picture looks more appealing, we'll wait to move into the Alternative Energy field.

But we're not going to try to time the market. Developing Alternative Energy sources is a long, tough slog. Given this recessionary economy, we expect it to slow down the momentum of the whole Alternative [Energy] movement. Everything that could be a portfolio diversifier over the longer term is on our radar screen. Even the CTI is a very promising long-term investment. We've tracked its behavior back to 1985, when the formula first came on the scene. Likewise, we're also closely following developments in everything from Water to Infrastructure and Agriculture, among others. We view Alternative Energy as a potentially attractive portfolio diversifier.

Source: Hedging Bets by Going Long and Short