For the same reason we liquidated our position in TIPS (Treasury Inflation Protected Securities) earlier this year, we’ve made a change in the commodities category. You might be asking yourself, why would terminating a bond position like TIPS prompt a change in commodities?
Hint: It wasn’t the commodities exposure that gave us concern.
I’ll need to briefly explain how commodity related mutual funds work for the explanation to make any sense. These funds don’t invest directly in physical commodities. In other words, they’re not buying gold, corn, crude oil, etc. and storing it in a large warehouse somewhere. They invest in commodity-linked derivatives (contracts) designed to track the prices of the underlying commodities. This is a much more efficient and liquid method of gaining exposure to the asset class.
These contracts only require an initial percentage of the total value (or margin) to get started. If the fund buys a $100,000 wheat contract and puts up $20,000 as margin, then the remaining $80,000 collateral is invested in bonds or cash. As you can see, what the collateral is invested in can have a huge impact on the overall performance of the fund.
Our former commodity fund, PIMCO Commodity Real Return Strategy (PCRIX) invests the collateral in TIPS, with a duration of 6-7 years, exposing the fund to a fair amount of interest rate risk. As rates rise, bond prices fall. The fund has had a phenomenal track record over the last 10 years, ranking number one in the category. But as interest rates have started to creep up, the fund has suffered because of their collateral investment in TIPS.
Going forward we feel that a purer play on commodities makes the most sense, given the interest rate environment. We’ve chosen the PIMCO CommoditiesPLUS (PCLIX) fund. The fund is managed very similarly to PCRIX with the exception of the collateral, which they invest in very short-term fixed income (keeping duration less than a year), and therefore not exposing the fund to much interest rate risk.
Commodities are a great diversifier to an investment portfolio, and we’re confident in PIMCO’s ability to navigate the road ahead with this new addition to our client portfolios.