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The Long and Short of Commodity Investing

Three new funds that reinvent the wheel of commodity investing.

Mallory Horejs, 06/07/2012

Over the past decade, more and more investors have turned to commodities to enhance portfolio diversification. Investments in commodity mutual funds, for example, have grown from $9.2 billion at the end of 2002 to more than $137.6 billion by the end of 2011. The growth story for commodity-tracking exchange-traded funds is even more impressive--assets have skyrocketed to $150.4 billion from $770 million over the same period.

Furthermore, the strategies  used to gain commodity exposure continue to evolve. While the industry's earliest products invested in commodity-related stocks, futures-based strategies continue to make up a larger piece of the commodities pie. Although the first physical commodity exchange-traded fund wasn't launched until 2004, today nearly 70% of all commodity ETF assets are held in futures-tracking and physical-commodity funds.  

The most recent innovation in the commodity space, however, is the availability of long/short strategies in mutual fund form. Rydex launched the first long/short commodity offering in June 2009, now called Guggenheim Long/Short Commodities Strategy RYLBX. This fund's management team uses a systematic, rules-based strategy to identify price trends, both positive and negative, in a subset of commodities included in the S&P GSCI Excess Return Index. More recently, several similar products have come to market, two within the past six months. These shops all argue that taking a momentum-based long/short approach to commodity investing serves investors better than long-only strategies. And this technique couldn't be more timely--due to increasing fears of a global economic slowdown, the S&P GSCI Index is down 8.3% for the year to date, while Guggenheim Long/Short Commodities Strategy is up 4.5% (using monthly data through May 2012).

Forward Commodity Long/Short Strategy FCMLX
This index-tracking fund seeks exposure to the commodity markets and returns that correspond to the Credit Suisse Momentum and Volatility Enhanced Return Strategy Index, or Credit Suisse MOVERS Index. The index uses a systematic allocation model, which generates long/short signals for a broad universe of 24 commodities on the basis of market performance and realized volatility. 

From this group, the 10 commodities with the strongest absolute signals, filtered by volatility, are grouped together in an equally weighted basket. The basket can be composed of all long, all short, or a combination of long and short positions. Each month the basket’s composition is reweighted using the quantitative strategy and will consist of a new selection of 10 commodity long and/or short positions exhibiting the strongest (bullish or bearish) momentum signals. As of March 31, 2012, the fund held 10% long positions in WTI crude oil, unleaded gasoline, aluminum, silver, and live cattle. The portfolio also had -10% positions in natural gas, lead, wheat, Kansas wheat, and coffee. 

The primary advantage of this fund's index-based long/short commodity approach is its cost effectiveness. While the Institutional share class's 1.52% net expense ratio may seem high for an index-based product, it's still small potatoes relative to what other managed-futures funds are charging. The average managed-futures fund costs 2.73%, but that doesn't always account for the fees paid to the underlying commodity trading advisors. When fees reign supreme, Forward Commodity Long/Short Strategy is worth considering. 

LoCorr Long/Short Commodity Strategy LCSAX
In contrast to Forward's index-based structure, LoCorr Long/Short Commodity Strategy takes an active approach. This fund can invest up to 25% of its assets into a portfolio of diversified commodities futures positions, which is run by Millburn Ridgefield Corporation. (Futures contracts are leveraged and therefore do not require large, upfront investments to get 100% exposure.) Galliard Capital Management subadvises the funds' remaining 75% of assets according to a fixed-income strategy of short- to intermediate-term investment-grade corporate and government-agency bonds.

As of March 31, 2012, Millburn held roughly 50 long and short commodity futures positions allocated across the following sectors: energy (31%), grains (23%), metals (22%), softs and lumber (18%), and livestock (6%). To construct the portfolio, Millburn utilizes both trend-following and nontrend models (such as pattern recognition, event, intraday, fundamental, and relative value).

Mallory Horejs is an alternative investments analyst with Morningstar.

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