Some Commodities Funds Pull Back
As the Run-Up Begins to Lose Energy
By SHEFALI ANAND
September 15, 2006; Page C1
Some of the hottest mutual funds of the past year — ones that invest in commodities like oil and natural gas — are starting to take it on the chin.
In the past month, natural-resources and energy funds as a group have lost 6.7% of their value, according to tracking company Morningstar Inc. That has erased a big chunk of their gains for the year: Overall, they’re up only 2.6% year to date. For comparison, the broad Standard & Poor’s 500-stock index is up 5.6% year to date through Sept. 13.
In the short term, the steep declines in commodities funds is bad news for mutual-fund investors, given that so many people piled into these funds in the past few months, which means they missed much of the run-up. Indeed, many investors are still putting their money into these funds. For instance, the $12.18 billion Pimco CommodityRealReturn Strategy fund gained more than $100 million from the start of the year through Aug. 31. Portfolio manager John Brynjolfsson describes the fund’s growth in the past few years as “astronomical.”
Commodities prices are famously volatile — oil prices can soar on Mideast tensions; gold tumbles when inflation worries ease — so they easily could swing back again. And there are a few relatively bright spots. Funds focusing on gold and precious metals are still up 16% since the start of the year, even though they have fallen back a bit recently.
But other important assets are in sharp reversal. Just yesterday, natural-gas prices fell 10% to their lowest close in two years, on news the Energy Department has bigger-than-expected natural-gas inventories. Overall, prices are down 68% from a peak in December.
That is just one of several reasons why energy-heavy funds have been hit particularly hard. After touching a high of about $77 a barrel in July this year, oil closed at $63.22 yesterday, partly due to high inventories of oil in the U.S.
The price swings hammer home the fact that funds like these are best used as a way to diversify a portfolio, but not as a core holding. The advantage of commodities is that their prices generally don’t move in sync with stock or bond prices — and thus, a modest holding of commodities in a portfolio can stabilize the portfolio’s returns over the long term.
Investors already in these funds shouldn’t panic. However, investors who have held the funds for a few years might take this as an opportunity to trim back those positions if the funds have appreciated significantly since they were purchased.
For people who have sat out the commodities run-up, now might not be an auspicious time to jump in. The best strategy is to put only small amounts of money into funds like these, over an extended period of time, rather than try to guess whether or not the market has peaked or hit bottom.
With the sharp jump in oil prices over the past year or so, “I’d be hesitant to even start initiating that piece now,” says Scott Greenbaum, a fee-only financial adviser based in New York.
Commodities can move in long cycles. For instance, gold prices went into a 20-year bear market after peaking in the 1980s, and picked up only during the past few years. Fears about inflation, terrorism and the possibility of a weakening dollar have been driving its price.
The jury is still out about whether the rise in commodity prices is near its peak, though some economists think so. Earlier this month, Morgan Stanley’s chief economist, Stephen Roach, said that “the mega-run for commodities has run its course.”
Others think the price retreat of the past month or so is a temporary blip. Robert Shearer, portfolio manager for the Merrill Lynch Natural Resources Trust fund, says the current decline in price of oil is one of about five downdrafts since 2005. “We’ve not seen a fundamental change in the supply and demand,” says Mr. Shearer, who is bullish on the long-term prospects of oil. His fund has about 80% of its $418 million in stocks of companies that work in energy-related fields, such as exploring, drilling or refining natural gas or oil.
Natural-resources stock funds are distinctly different from some funds that include the word “commodity” or “real assets” in their name, as these commodity funds don’t buy stocks of companies. Instead, they buy complex financial instruments called “derivatives” to mimic a broad commodity index. For instance, the Pimco fund attempts to track the performance of the Dow Jones-AIG Commodity Total Return Index, which is made up of 19 commodities including oil, gold and some less-snazzy ones like soybeans and live cattle.
While funds like these are less dependent on one particular kind of commodity — making them more diversified — investors should note that some can trigger higher taxes. The Pimco fund, for instance, pays part of its yield to investors in the form of ordinary income, which is charged at an individual’s income-tax rate, which can be higher than other rates.
The fund’s manager, Mr. Brynjolfsson, believes the bull market in commodities is “alive and well,” but points out that a lot depends on the broad economy. “If we were to go into a recession or a slowdown, commodities would likely fall further,” he says.
On the other hand, if inflation were to accelerate, or even worse, the economy were to experience so-called stagflation — a situation with relatively high inflation but stagnant economic growth — commodities would be among the few sectors that would do well, he says. The Pimco fund is down 5.5% year to date and is negative 3.3% for the past 12 months, but it is up about 15% a year for the three years ended Sept. 13, according to Morningstar.
“Hopefully, all commodity investors are investing with a long-term view,” says Mr. Brynjolfsson.
