First up is an interview with Jason Zweig at Advisor Perspectives. I tend to read a good bit of his stuff as there is usually an interesting nugget or two but I tend to disagree with his conclusions. Candidly I do not know much about his background other than he's been a prominent writer for quite a while. I have no idea if he has ever been a decision maker in any sort of investment capacity.
In the interview he has some interesting things to say to advisors about making sure they try to understand how risk and volatility work (I have no idea how good his understanding is).
He goes on to say a couple of other things that I think are overly simplistic. He says "The financial advisory community has fallen hook, line, and sinker for the Wall Street propaganda that every investor should have at least 10 percent of their assets in commodities" which he says is unfortunate. He notes that commodities have generally gone down in price over long periods of time so owning them, in that light, is not ideal.
Well I've never been in the 10% camp so I do not quibble with that. The interview does not cite the period of time he is talking about. He made a comment about how long it took to break even in gold for anyone who bought at the high. If part of the reason to own commodities is that they usually have a low correlation to equities and equities had a massive super cycle to the upside from 1982 to 2000 then a poor result in commodities is far from a black swan. Without knowing the time period he had in mind, from a performance standpoint commodities were not important for most of the 1980s or the 1990s.
However during this past decade they were very important as US equities dropped 24% pricewise. Ten years ago gold was around $300 versus a little over $1000 now, Copper was a little less than a dollar versus about $3 now and soy beans more than doubled.
In thinking about commodities for the next decade will they matter or not? To figure that out do you want to rely on what happened in the 1980s or do a forward looking analysis on supply and demand trends around the world? Asset allocation and portfolio construction is not as simple as people like Zweig make it out to be (in his articles anyway, I've never read one of his books).
The other item came from a reader who asked if I've compared returns of stocks I've picked versus ETFs. It is not that simple. Not every stock lends itself to an easy comparison to an ETF. Yesterday I mentioned my Brazil stock, which is Vale (VALE), had lagged EWZ last year but has beaten it in other years. Over five years (I've held it a little longer than that) VALE is about 50% ahead of EWZ. Additionally I sold some in the mid to low $30s in early 2008 so how would I compare the two? I own a Brazilian stock because I do not want to own Brazilian financials and EWZ is heavy in financials.
I've disclosed owning Caterpillar (CAT) which has generally outperformed the Industrial Sector SPDR (XLI) but it doesn't always. However I traded it a couple of times along the way so comparisons are difficult. One name that has not worked out so well is China Mobile (CHL). I bought way below its high but it is down from where I bought it. I'm not sure there is an ETF that makes for an easy comparison. Part of the reason I chose it is that I want to avoid financial companies from China. In the time I've owned it it has done about the same as FXI but even if it had lagged badly I am unwilling to risk client money in Chinese financials.
Up to this point the conversation has ignored the concept of risk adjusted return. In a properly diversified portfolio some stocks could be thought of a volatility dampeners so with those beating something is not necessarily the goal. I recently disclosed swapping Monsanto for MOO. These two probably are more of a direct comparison in the context that the reading is asking. As I disclosed however, MON started out better than MOO and then lagged. MOO went down much more during the worst of the bear and so bounced back a lot more and so while these two might be comparable I am not sure the action taken allows for a comparison.
To repeat it just isn't that simple.
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14 comments:
Commodities are a zero sum game. Winners and losers sum to zero. At the end of the day a pound of copper is still a pound of copper.
Stocks represent companies that can expand, innovate, etc. stock holders winners and losers are not a zero sum game as the companies become more valuable over time.
This is why many of us like stocks and do not like commodities, but from a trading perspective commodities have been doing well for a decade and will continue to do well for years to come.
Yes I knowingly ignored commodity stocks for illustration purposes. But over a 100 years commodities are usually not a good bet even if they have their moments.
SEG
"Commodities are a zero sum game. Winners and losers sum to zero. At the end of the day a pound of copper is still a pound of copper."
To follow your argument to its end, you should go all in on commodities. 'cause we'll run out. and right before we run out, you'll get ridiculously rich.
That said, the truth lies somewhere between the "omg don't own it" and the "omg own it" camps.
I think it was Arnot who did a long term study of commodities, esp. gold, for Financial Planning magazine. Over the long haul, commodities ARE a zero sum game when inflation is taken into account. However, as Roger says, they tend to have low correlation with equities. So having a small portion of your portfolio (I believe the suggestion was 3%, not more than 5%) in commodities reduces overall portfolio volatility and can therefore slightly improve your return.
As an agricultural producer, I find that I am in agreement with Zweig. Agricultural commodity futures (as I presume is the case for other futures markets) exist to transfer price risk from one party to another. Real long term profts in the underlying business don't normally occur in commodity prices per se, but though innovative technology and improvements in production methods. I would also caution against looking at a chart of commodity futures and trying extrappolate anything out of it. Markets are heavily influenced by completely unpredictable natural and political events. Just look at the impact the ethanol craze has had. I would also wager that the public really has no idea how much USDA farm policy impacts prices and planting decisions.
I know from Zweig's writings that he is an investor and not a speculator. If the long term real returns of commodities as an investment class has been negative, I for one cannot disagree with him to exclude that class from a portfolio. As you like to say Roger, the risk is in not having the money when you need it.
Goodness gracious, my spelling and grammar is atrocious! Apologies to everyone.
I know that this may be implied by others --- but just wanted to mention that its not enough that something simply be non-correlated to be included in a portfolio. It also needs to have positive expected return. So that is the more important question, imo. (one which I have no answer of course, up to the investor to decide that).
But separate from that -- one other issue with commodities is that they are both 1) quite volatile and 2) generally quite sensitive to the overall economy -- which is what the stock market is sensitive to. In times of crisis, its been shown over and over again that correlations generally rise, so that you thought you were getting non-correlation, but instead you just get a more volatile asset that delivers an even larger drawdown for your portfolio. An excellent example is what just happened with crude oil in 2008, see images:
www.etfreplay.com/blog/image.axd?picture=2010/2/USO+vs+SPY.png
www.etfreplay.com/blog/image.axd?picture=2010/2/USO+vs+SPY+2.png
Stephen Drone,
Not my theory about commodities. This is commonly taught in economics courses I have taken. Winners and losers sum to zero.
Commodity stocks are a different issue as are stocks in general.
SEG
"I know that this may be implied by others --- but just wanted to mention that its not enough that something simply be non-correlated to be included in a portfolio. It also needs to have positive expected return."
YES
Written expression is not my forte, but I am a pretty good analyst.
"Winners and losers sum to zero." is just, well, silly.
While literally you can make a case it's true, if it actually were true you wouldn't be here, since there'd be no reason to invest in anything that currently exists (savings accounts included). The only way to make money would be venture capitalism.
It is true that the net sum of winners and losers in commodity futures contracts is zero.
But then again, their purpose is to transfer price risk. The seller of a futres contract sets a floor on his price, while a buyer sets a ceiling. The only way out of a position is to buy or sell an offsetting position or to deliver or take delivery of the underlying commodity.
Question for everyone:
Isn't the practice of awarding CEO's and other executives huge stock awards, similiar to the printing of money?
Seems to me....the actual owners of the company, the shareholders, get screwed.
Stephen,
I use futures for hedging sometimes and volatility gives you lots of bang for the buck but futures or any other derivative based on a cash market has to be zero sum because it is a time-limit contract, typically on a specific spot price. Either the seller of the contract makes a premium or the buyer does, they can't both do it. It's more complicated than that in practice -- the seller might be a producer hedging a portion of what they produce so they could benefit even if the spot price was higher than the forward contract -- but the contract considered in isolation will have a winner and a loser.
As SEG points out, this is not the case with equities: They (and lots of other assets) have no set time limit and/or no specific cash market they are derived from so the sky's the limit given enough time. Stocks are often portrayed as a share in the ownership of a company but it would probably be more accurate to say a stock is a derivative of corporate earnings, priced at the present expected value of its future cash flows from operations (which expectation naturally, um, fluctuates).
But I suspect WH has more to add to the subject since (assuming he is the Anon I think he is) he uses Ag futures as part of his business.
People tend to cite John Husman a lot around here. Here is what he has to say on the subject:
"John Hussman: For the typical investor, I don't believe that a standard commodity allocation, a standard TIPS allocation, or a standard allocation to a lot of passive classes is a good idea. If you look at precious metals and precious-metals shares over the long run, they tend to have a negative beta. You would expect that the long-term return on those kinds of assets would look a lot like the long-term return on anything that has some insurance properties, which is that they provide relatively low sustained returns. So, I don't think investors do themselves a lot of good by having as a passive asset class a fixed allocation to precious metals or to a wide range of alternatives."
From Morningstar, "Asset-Allocation Heavyweights Square Off"
Full interview here,
http://bit.ly/b0GXD3
Roger:
Thanks for the reply on the stocks versus ETF's question. It's not simple, that's why I asked. If you are successful at adding value on a risk adjusted basis by owning stocks instead of sectors, them there is hope for me. if not, i'm likely wasting my time. The drag on an ETF is less than 0.5%, and the diversification affords some protection from stock specific risk. I am a value investor, incorporating the tools you espouse for risk management. This is not real complicated. It also works out pretty well. But I'm not able to separate smart from lucky in my own portfolio. I have no control for comparison. Since you are managing multiple accounts, using a similar philosophical basis, you would be able to look at the value added component of stocks from etf's. I'm not challenging your stock picking abilities, but trying to assess if owing individual stocks have increased returns to your various portfolios over a pure etf portfolio. I've been studying volatility as a tool since you mentioned it several months ago. I've come to appreciate the power series appreciation in SDS, as a result of your posts.
Thanks,
Sam
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