Financial advisers and money managers who have loaded up on commodities with the aim of diversifying their portfolios have made a troubling discovery: These alternatives continue to move nearly in lock step with the stock market.
“The sense I'm getting is that it wasn't so unexpected to see a spike in correlation during the crisis,” said Kathryn Young, a commodities fund analyst at Morningstar Inc. “What's unexpected is how long that correlation has lasted and how long it has been persisting.”
Although commodities typically are added to portfolios for their tendency to move in the opposite direction of stocks, they — like most asset classes — were hit hard during the market downturn of 2008.
But the correlation between commodities and the stock market endures. Although that correlation isn't exact, the two groups of securities generally have been moving in the same direction since the market meltdown in 2008.
The average commodities fund posted a loss of 8.9% for the three-year period ended Aug. 16, compared with a 6.5% decline for the S&P 500, according to Morningstar. Year-to-date, the average commodities fund had a 6.4% loss, compared with a 2% drop for the S&P 500.
This comes as retail investors have been flocking to exchange-traded funds that invest in commodities and as target date fund managers are adding alternatives to their funds in the name of diversification.
For example, Fidelity Investments added the Fidelity Series Commodity Strategy (FCSSX) to its target date fund series last year, MFS Investment Management added the MFS Commodity Strategy (MCSAX) to its target fund family, and T. Rowe Price Group Inc. added the Real Assets Fund (PRAFX) to its target lineup this summer.
So far this year, 11 commodities-driven funds have been launched, versus eight in all of 2009, according to Morningstar.
So far, the correlation between commodities and the equities markets has been driven largely by base metals and energy, according to Ms. Young.
Some of the correlation may also be tied to a weakened world economy and poor investor confidence, said K. Geert Rouwenhorst, a professor of finance at the Yale School of Management and a partner at SummerHaven Investment Management LLC, a quantitative-investment manager of commodities futures.
“The increase in correlation is probably more of a general weakness in the world economy that reduces demand for commodities and places downward pressure on stock prices,” he said. “Whether that correlation is something temporary [or cyclical], or whether it's something that more or less reflects a change in commodities markets, we really don't know.”
Whatever the case, the correlation has caught the attention of advisers and fund managers, and it has forced many of them to reconsider their investments in commodities.
“We would agree that what we have seen over the last few years is that energy and material stocks have a higher correlation to the Standard & Poor's 500 index,” said Jonathan Diorio, a director and product specialist at DWS Investments Inc.
As a result, he said, the managers of the DWS Enhanced Commodity Strategy (SKNRX) in April shifted from investing in stocks and commodities to buying commodities directly through swaps.
“We're using more-hedged strategies like merger arbitrage,” said David M. Carter, chief investment officer at Lenox Advisors Inc. The firm, which manages $1.3 billion in assets, has been raising its allocation to mutual funds that practice those strategies and scaling back its exposure to commodities.
Managed-futures mutual funds are directional-trading investments that provide an alternative for managers; they are long or short commodities futures contracts, based on the rising or falling pricing trends of commodities, said Chris Reuschle, a senior partner at RFW Wealth Advisors.
Managed-futures strategies have always been accessible to institutional investors, but those strategies are becoming increasingly available to individual investors through mutual funds such as the Princeton Futures Strategy Fund (PFFAX), which was released in July.
Not everyone thinks that commodities and equities will move in lock step for long.
“I think the correlation is a short-term factor,” said Russell T. Hill, president of Halbert Hargrove.
“As we develop mechanisms like ETFs, they diverge from underlying commodities and become a stock,” he said. “Those correlations might be higher, but I don't think futures contracts in commodities will be highly correlated with stock markets.”
Michael J. Francis, president of Francis Investment Counsel LLC, which works mostly with 401(k)s, agrees.
“In 401(k)s, the only realistic way to get real assets is through the commodities funds — futures-related, bundled baskets of derivative securities that are designed to mirror a basket of commodity futures. In the big picture, we're not dissuaded from that message,” said Mr. Francis, whose firm has $4.4 billion in assets under advisement.
“I believe that the economy and these correlations themselves are cyclical, and what ebbs will flow,” Mr. Francis said.
E-mail Darla Mercado at -dmercado@investmentnews.com.
