More Than Meets The Eye

That's the reason that you find that some of our largest holdings–in fact the overwhelming majority of what appears to be our assets–are allocated to this basket of short-term, high-quality fixed income securities. Make no mistake about it, this is first and foremost a commodity product.

But when you look at the research, it still seems there's a lot of cash in there. That's because we still have our cash and it's Angelo's decision as to whether it's more attractive to simply do an overnight repurchase agreement with that cash, essentially a one-day fixed income instrument, or to buy a six-month Treasury bill, or a one-year government agency security. The repurchase agreement is a large portion of the fund, but what you're earning is short-term overnight interest on that security. The percentage of our repurchase agreements will fluctuate from time to time as [Manioudakis] finds more attractive alternatives in the market. The [fund's] large cash position shouldn't be mistaken for a manager who is bearish and is not fully invested in the core assets.

The fund's had years when there's been a huge negative return followed by several years of positive returns. Why does that happen? You could look at the last three or five years and say, "Wow, commodities have been an outstanding investment–look at these strong returns." But if you look at the longer history, you'll find there's been a very consistent pattern of negative correlation between commodities and stocks or bonds.

Commodities are not immune to negative returns, but the return pattern is different than for stocks or bonds. When you add commodities to an investment portfolio, you're getting a much more efficient portfolio, which maintains its return profile but with lower volatility.

A lot of people say we're coming to the tail end of a positive cycle for bonds. What impact would that have on your fund? There are two important things we need to address to answer that question. One is that the bonds we hold as the collateral in this portfolio are very short-term in nature: The interest rate risk of the portfolio looks very similar to the interest rate risk of a three-month Treasury bill. That's why I made the comment earlier that this is, first and foremost, a commodity fund. We don't want the investor holding a lot of interest-rate risk.

When we look at fixed-income securities, we're looking for short-maturity instruments. For the ones that are not short maturity, we go into the futures market and hedge out that interest rate risk. A rising interest rate should not be detrimental.

When we look at commodities and the historical performance of commodities relative to bonds, again what we find is this negative correlation between these assets. There are business cycle reasons for this. Quite simply, when economies are growing above trend, as they are now, often we'll see interest rates begin to rise. When economies are growing, the demand for commodities is growing.

Will rising interest rates have any effect on your commodity investments? Rising interest rates have limited effects on our returns. In some ways they actually contribute to our returns because these short-term, fixed-income securities we're buying are ultimately being replaced with higher-interest-earning fixed-income securities. The more important issue is the bigger business cycle environment we're operating in. If interest rates are just rising gradually, that's a function of a growing economy and is likely to [create] an environment where commodities are going to be performing positively.

Where do you see the Real Asset fund fitting into the typical investor's portfolio? We look at this as a 5% to 15% maximum allocation to an investor's portfolio since it's meant to complement the stocks and bonds that they hold. It certainly should not be looked at as a stand-alone investment. The long-term returns of commodities have been strong. In fact, over the last 35 years, commodities have generated returns equal to or better than the S&P 500. So [the fund] is a strong long-term investment.

Why should an investor put their money into this fund as opposed to a similar investment? If by similar investment you mean a natural resource equity fund, there are some very important differences between these two. With a natural resources equity fund, you're buying the equities of companies in the commodity-producing business. When we look at the historical return profile of those equities, they are most directly impacted by changes in the broader equity market, not necessarily changes in the underlying commodity prices.

What do you see happening in the commodity market in the next six to 12 months? We do not spend a lot of time trying to make directional predictions or forecasts on the individual commodity markets. Our active management strategies are built more around relative value opportunities between commodities within sectors. But the variables, of course, are always supply, demand, and inventory. We see that demand is growing. Economies around the world are growing. Turning to supply, we are seeing modest increases in the supplies for certain commodities, but supply responses do not occur overnight. They take, in most cases, several years to play out. So we're probably a couple of years away from seeing a material supply response in many of these markets. The third variable is inventories. Several commodities markets have seen some rise in inventory levels, but across the board, we're still looking at below-normal, below-trend inventories for most commodities.

I think when you add those three components together, it's not surprising that we've seen a bull market in commodities. Commodity prices have been appreciating because the fundamental environment is good for commodities.

Staff Editor Robert F. Keane can be reached at [email protected].