I first heard about commodities futures in the last bear market. In 2002, commodities futures returned something like +25-30% while the S&P lost 22%. People were saying back then commodities futures were a great investment because they had “equity-like” returns while being uncorrelated with the stock market. This characteristic would add diversification to one’s portfolio and at the same time not reduce its return like adding bonds would do.
PIMCO introduced a commodities futures fund for retail investors in 2002. I wasn’t so convinced by the story. In my mind I had always associated commodities and futures with speculation. I also thought people were chasing performance while justifying it by saying they were doing it for diversification.
Since then, commodities futures funds had very good returns, all the way through the summer of 2008, driven by rapidly increasing prices of oil, agriculture products and metals. I was watching on the sideline thinking somehow I missed the boat. Then it crashed down hard. In a period of about five months, the price of the PIMCO fund dropped over 60% (blue line is the PIMCO fund; red line is S&P 500).
Now that nobody wants commodities futures anymore, it’s time for me to build up a position. I bought PIMCO CommodityRealReturn Strategy Fund D (PCRDX) on Dec. 5, 2008*. This fund invests in derivative contracts linked to the Dow Jones AIG Commodity Total Return Index with the collateral invested in inflation-indexed bonds. I chose this fund because its index is well balanced among many commodities, not dominated by energy products. The current index composition is roughly as follows:
Source: iPath ETN.
I also considered these other investment vehicles in the commodities futures space before I settled on the PIMCO fund:
- PowerShares DB Commodity Index Tracking Fund (DBC) – Only six commodities, 55% in energy.
- iShares S&P GSCI Commodity-Indexed Trust (GSG) – many commodities but 68% in energy.
- iPath Dow Jones-AIG Commodity Index Total Return ETN (DJP) – ETN brings credit risk from the issuer. I don’t want to take that risk.
The PIMCO fund D share is more expensive at 1.24% expense ratio but it requires a low $1,000 initial investment. It’s also no-transaction-fee (NTF) from most brokers. Because I’m only starting with a small amount in an IRA, the extra expense ratio isn’t much in actual dollars. When I accumulate more in this fund, I can exchange it to the less expensive Institutional share (PCRIX) which is available at Vanguard for $25,000 initial investment.
The price I paid was about $5.61 a share after adjusting for year-end distribution (story about that one forthcoming). So far it’s up 5% already. Let’s see where it goes from here.
If you’d like to learn more about commodities futures, there are a ton of papers linked in the Bogleheads Wiki article on commodities.
* The purpose of this post is to document what I was thinking when I added this new position to my portfolio. It’s not a recommendation for anybody else to do the same.