by Mike Schnitzel.
In light of reopening demand and supply chain issues, commodities are broadly experiencing price pressures which, while not so good for consumers, can be a boon to commodity companies. One would assume this would translate to commodity funds. And in terms of flows, they have this year. Year to date, Commodities General Funds have seen inflows of $11.6 billion through May 31. They lost money the past two years, experiencing redemptions of $3.3 billion and $3.2 billion, respectively.
The Lipper Commodities General Funds classification encompasses funds which invest primarily in a blended basket of commodity-linked derivative instruments or physical commodities. In inflationary times, investors often flock to commodities, which in general have a lower correlation to equities and bonds and can flourish when there is inflation.
To help us evaluate top-performing funds in this space, we can turn to Refinitiv Lipper Leaders. The Lipper Leaders Rating System uses metrics to help investors identify funds that might be suitable for their portfolios. Funds are ranked against their peers on each of five measures: Total Return, Consistent Return (risk-adjusted return), Capital Preservation, Expense, and Tax Efficiency. These metrics can be used alone or in combination to build individualized portfolios that suit an investor’s particular goals. They are rated from 1 to 5, with 1 being lowest performing and 5 being highest performing. The ratings can be used by fund selectors, financial advisors, and investors to find top-performing funds in all of the Lipper classifications.
Using Lipper Leader metrics, one of the best Commodities General Funds is the Parametric Commodity Strategy Fund, Institutional Shares (EIPCX). As of May 31, the fund had a three- and five-year Lipper Leader rating of 5 for Consistent Return and Total Return, and a three- and five-year Lipper Leader rating of 4 for Capital Preservation and Expense. We spoke with fund manager Greg Liebl to examine the strategies he uses to manage the fund, and his outlook on commodities funds in general.
Liebl said that commodities offer protection against inflation that does not exist in many other classifications. “A basket of commodity futures can give you inflation protection. Equity and bonds respond well when inflation is moderate or near expectations,” Liebl said. “I think historically investors haven’t had asset class exposure to a class that does well in an inflationary environment. Inflation protection is very important for investors to consider as to why to include commodities in a portfolio.”
Over the long term, commodities have provided solid returns to investor portfolios, Liebl said. He noted that their returns can ebb and flow because they are dependent on the business cycle moreso than equities and bonds.
Liebl uses a very systematic strategy to manage EIPCX, and it rests on three key elements—reweighting, rebalancing, and curve positioning. “If we have a period where rebalancing is not as impactful, the other two might counteract that, and this helps to generate that consistent return we’ve been able to accomplish. Over every three-year time period since inception, we’ve been able to outperform the fund’s benchmark,” he said. “Historically, it hasn’t mattered when an investor has chosen to invest with us. Three years later, they’re better off investing with us than a passive strategy. We’ve seen consistent returns when commodities have been doing well and when they haven’t. The strategy produces a more consistent performance record versus the benchmark.”
EIPCX outperforms its benchmark, the Bloomberg Commodity Index year to date (16.2% to 15.8% as of April 30) and in the one- (58.4% to 48.5%), three- (7.2% to 1.6%), and five-year (6.6% to 2.3%) periods. This beats the average of its Commodities General Fund classification performance over the three- and five-year periods.
Liebl said his fund only invests in commodity-linked derivatives rather than physical commodities for several reasons. “It’s not practical to invest in the physical market given you would need to transport [the commodity], insure it, and have storage for it,” he said. “Many physical commodities have spoilage costs, though there are some exceptions—gold. Investing in physical gold is straightforward.”
Managing risk, rebalancing
One of the key ways the fund achieves this performance is through a focus on risk management. Liebl says he starts the investment process by creating as diverse a portfolio as possible. The primary filter when selection commodities on its benchmark index is liquidity. “We want to include as many commodities as we can that are liquid enough to trade in a systematic way. We have 32 commodities [in our fund portfolio] and the most diverse way [to allocate] would be to equal weight,” he said. “Instead, within the portfolio, we assign commodity exposures at equal weights to four liquidity tiers.” Liebl said once they have that broad set of targets, they put in rebalancing target weights of plus/minus 20%. “It’s a systematic process that helps reduce drift in the portfolio,” he said.
Liebl said Parametric conducts its rebalancing in two ways. “We first recognize that derivative exposures periodically expire and must be renewed, which provides a low-cost opportunity to reestablish the portfolio weights at their target levels,” he said. “This is our preferred method of rebalancing, given that trading naturally occurs during this time. We next note that commodity markets are continuously exposed to exogenous shocks, such as a bad harvest in Ukraine or a hurricane in the Gulf of Mexico.” Liebl said prices generally overreact to such shocks at first, and this is followed by a “slight reversion” as markets process the information. “To exploit these price reversions and maintain diversification, we include rebalancing bands around each target weight,” he said. “If a portfolio position broaches this band at any time, it triggers a rebalancing trade to take that commodity’s position back to its target weight.”
Commodities General Funds is a fund classification that can provide downside protection in inflationary periods. Having active managers who know how to invest in commodities can help investors juice returns and beat benchmarks, helping to blunt any losses that inflation causes in the equity and bond sleeves of their portfolios.
The views expressed are the views of the author and not necessarily those of Refinitiv. This material is provided as market commentary and for educational purposes only and does not constitute investment research or advice. Refinitiv cannot be held responsible for any direct or incidental loss resulting from applying any of the information provided in this publication or from any other source mentioned. Please consult with a qualified professional for financial advice.
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