Should I Have Held Commodities In My Portfolio?

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Includes: PCRIX, QRACX, SPY, VIPSX
by: Jon Luskin

Summary

Commodity funds manifest inferior risk-adjusted return, relative to other asset classes.

Absence of conclusive superior risk-adjusted returns for portfolios holding commodity funds.

Commodity performance as an investment varies by the particular fund (proxy) used.

Commodities are a relatively new asset class. (They are new at least with respect to domestic equities.) That is, it was only within the last dozen years that a lay investor could get their hands on a commodities mutual fund. And as with many new investments, the fledgling commodities fund history has been relatively volatile; the previous bull run has turned bear. Given this asset class's poor performance, this begs the question:

When it comes to commodity funds, is it time to throw in the towel?

The buy-and-hold investor, however, would not even be asking this question. For the buy-and-hold investor, the question is:

Should I hold commodities in my portfolio?

We can attempt to answer this question by examining how commodities have performed, or rather:

Should I have held commodities in my portfolio?

Commodities as an Investment

How does one invest in commodities? For the lay investor, there is one option: through a fund. This could be either a mutual fund, or an exchange-traded fund (ETF). The fund is the most appropriate investment vehicle because a lay investor is not apt to take out a futures contract. For the convenience and simplicity of investing in commodities through a fund, the fund investor is charged an annual expense (ER) ratio. (The significance of this expense ratio is discussed in the final section of this paper.)

Data

Two commodity funds are examined:

  1. Oppenheimer Commodity Strategy Total Return Fund Class C (MUTF:QRACX)
  2. PIMCO Commodity Real Return Strategy Fund Institutional Class (MUTF:PCRIX)

These two funds were chosen because performance data is available for 12 consecutive fiscal years. While there are numerous other commodity funds available for analysis, the dates of inception of those other funds are relatively recent.1

As a point of comparison, the performance of a popular S&P 500 index fund is shown:

  1. SPDR S&P 500 ETF Trust ETF (NYSEARCA:SPY)

Similarly, information on a low-cost Treasury Inflation Protected Securities (TIPS) fund is provided.

  1. Vanguard Inflation-Protected Securities Fund Investor Shares (MUTF:VIPSX)

A TIPS fund is shown as a reference point because, like commodities, TIPS may function as an inflation hedge. (A common argument for including commodities within an investment portfolio is that commodities may act as a hedge against inflation.)

Fund Performance

The time period evaluated is July 1st, 2002 through June 30th 2014.2 Both commodity funds showed relatively low correlation to SPY. However, the correlation of the commodities fund to the S&P 500 proxy is not as low as correlation of the S&P 500 proxy to the other inflation hedge just mentioned, the TIPS mutual fund.

 

SPY

QRACX

PCRIX

VIPSX

Annualized Return

8.1%

0.7%

7.1%

5.4%

Total Return

156%

8%

128%

88%

Risk, Annualized

16.4%

33.5%

27.1%

6.3%

Sharpe Ratio, Annualized

47.1%

16.6%

34.6%

63.3%

Correlation to S&P 500 Proxy, Annualized

1

0.21

0.29

-0.09

While correlation to the S&P 500 proxy is similar between the commodities funds, the investment returns of the two commodities funds is extremely distinct. (Note that the returns offered by the commodities funds are less than can be had with a plain vanilla S&P 500 index fund.) Further, both commodity funds are more volatile than the S&P 500. It is more risk for less reward. The result is significantly lower Sharpe ratios for the commodities funds than for the other asset class proxies examined (domestic equities and TIPS).

The performance of the two commodity funds is also very different. The Oppenheimer fund nets a negative real return - the investment return provided after the effect of inflation is considered. Thus, the argument for inclusion of commodities as an inflation hedge seems inaccurate - at least with respect to the Oppenheimer fund. If you held the Oppenheimer through the time period - you would have a netted a negative real return. (This ignores any transaction fees.) Unfortunately for the Oppenheimer fund, twelve years is a very long time to net a negative real return.

Performance of Portfolio Inclusion

Creating hypothetical portfolios showcases the value added (or subtracted) by the inclusion of the commodity funds within a portfolio. As a point of comparison, included is a portfolio of 60% equities and 40% TIPS. The portfolio is rebalanced annually. This comparison portfolio is created from the two other funds previously-mentioned: SPY and VIPSX.

Three hypothetical commodity-laden portfolios are created. The first two commodity-laden portfolios substitute a 10% allocation from equities in favor of a 10% commodities allocation. A final comparison utilizes both commodity funds, with a 5% allocation to each commodity fund.

7/1/02 - 6/30/14

60/40

50/10/40

QRACX

50/10/40

PCRIX

50/5/5/40

Total Return

136%

129%

139%

134%

Annualized Return

7.4%

7.1%

7.5%

7.3%

Standard Deviation, Annualized

9.9%

10.1%

9.9%

10.0%

Sharpe Ratio, Annualized

0.62

0.59

0.64

0.62

Sortino Ratio, Annualized

0.96

0.78

0.90

0.83

Depending upon the particular commodity fund used, total return and risk-adjusted return can decrease, or increase, relative to the standard 60/40 portfolio. Ultimately, the inclusion of the commodity funds in the hypothetical portfolio results in only small changes in investment return and risk.

Conclusion

The distinct commodity fund included makes or breaks the case for commodity fund inclusion within an investment portfolio.

Oppenheimer Commodity Strategy Total Return Fund Class C

From this analysis, it is quite obvious that the Oppenheimer fund does not add value. Quite the contrary; utilizing the Oppenheimer commodity fund would lower a portfolio's return and increase its volatility - a double loss. The poor performance of the Oppenheimer fund is reflected in the portfolio utilizing it - which posts the lowest Sharpe and Sortino ratios of the group.3

PIMCO Commodity Real Return Strategy Fund Institutional Class

The PIMCO Commodity Real Return Strategy Fund Institutional Class added a small amount of value - in the form of slightly higher return. Given the minute amount of total return added, one could make the case that the value added is negligible: roughly 10 basis points (0.10%) each year, given equivalent risk.

Should I Hold Commodities?

Given the small size of the data evaluated (i.e. just two funds), it may not be appropriate to make any conclusions. However, one factor that cannot be denied is the damage that an expensive fund (i.e. one with a high expense ratio) can do to a portfolio. The net expense ratio for the Oppenheimer fund is currently at 222 basis points, or 2.22%. This is in comparison to the S&P 500 index fund utilized, which has a net expense ratio of just 0.0945%.

With negligible value added from a still unproven asset class in just one of two funds, it is difficult to make a strong case for including commodities funds in an investment portfolio.

References

Bureau of Labor Statistics Data. (2014, October 29). Consumer Price Index - All Urban Consumers. Retrieved from Bureau of Labor Statistics Data.

Fidelity Investments. (2014, March 2014). QRACX - Oppenheimer Commodity Strategy Total Return Fund Class C | Fidelity Investments. Retrieved from Mutual Funds Research.

State Street Global Advisors (SSgA). (2014, September 30). SPDR® S&P 500® ETF. Retrieved from SPDR Exchange Traded Funds - Home.

US Department of the Treasury. (2014, October 24). U.S. Department of the Treasury. Retrieved from the U.S. Department of the Treasury.

Yahoo! Finance. (2014, October 24). PCRIX Historical Prices | Pimco CommodityRealReturn Strat Stock. Retrieved from Yahoo! Finance.

Yahoo! Finance. (2014, October 24). QRACX Historical Prices | Oppenheimer Commodity Strategy Total Return Fund Class C. Retrieved from Yahoo! Finance.

Yahoo! Finance. (2014, October 24). SPY Historical Prices | SPDR S&P 500 ETF Trust. Retrieved from Yahoo! Finance.

Yahoo! Finance. (2014, October 24). VIPSX Historical Prices | Vanguard Inflation Protected Se Stock. Retrieved from Yahoo! Finance.

  1. For a comprehensive analysis, a longer time period is preferred. This is because (temporary) periods of outperformance are common on relatively shorter timelines. By analyzing an asset's investment return over a (relatively) longer timeline, a more accurate measure of a position's value may be possible.
  2. All performance data was sourced from Yahoo! Finance, via the historical prices feature. Calculations were executed in Microsoft Excel.
  3. For the purposes of calculating the Sortino ratio, the minimum acceptable return is set at 2.42% - or the amount of inflation per the Consumer Price Index from July 2002 through June 2014, annualized.

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