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Chuck Jaffe
May 15, 2011, 12:01 p.m. EDT
By Chuck Jaffe, MarketWatch
BOSTON (MarketWatch) "” Mutual fund investors who decided a year or more ago to take a chance on commodities funds have now found out what all the warnings and danger signs were about.
The question is how they intend to deal with it.
Prices for commodities have risen dramatically over the last year, with a wide range of factors behind the trend. Many investors used commodities to hedge against a weakening U.S. dollar and the threat of inflation. Others liked the story of growing worldwide demand, especially from emerging markets, and then there was the turmoil in the Middle East and its potential to change the supply picture for oil.
No matter the reason, commodities investors were rewarded. The average broad-basket commodities fund returned around 40% more than the Standard & Poor's 500 /quotes/comstock/21z!i1:in\x SPX -0.44% over the last 12 months, according to Morningstar Inc. No one was complaining with annualized average returns well north of the 20% line.
But no one ever complains when the volatility is to the upside. If the Dow Jones Industrial Average /quotes/comstock/10w!i:dji/delayed DJIA -0.20% gains 1,000 points tomorrow, investors will be partying; if the market drops 1,000 points "” same move, different direction "” bolt the windows shut.
And over the last several weeks, commodities have shown that their volatility is not just to the upside.
Silver, among the biggest gainers in the commodity uprising, fell 27% in the first week of May alone, after hitting a 31-year high. Oil prices dropped 15% in the same week. Read more: Margin hikes threaten your silver, gold, commodities portfolio.
Over the last month, commodities-sector mutual funds suffered double-digit declines and have since bounced back. But few investors signed up thinking their funds would drop 7% in a month, about the commodities fund average as calculated by Lipper Inc.
This is the time in investment cycles where fund investors typically make their biggest mistakes. Unlike the sharpies who are in early on market moves, most buyers were late to decide that they needed more exposure to commodities than they might get through their ordinary fund. In fact, they were content until they saw the oversized gains commodities were putting up.
At that point, they decided it was time to make an allocation decision. They weren't buying commodities to get the hot asset class, because retail investors don't see themselves as timing or chasing the market. They just felt that the story was so good and the diversification benefits so strong that they needed to commit a piece of their portfolio to it. Read more: 5 money moves one gold bug is making now.
Now, however, they're reacting to the volatility and price drop. Measures of fund flows show money racing out of commodities funds, which means that some investors who bought at a high price are now selling low.
"If you are allocating the appropriate amount towards commodities "” no more than 10 to 15 % of the total portfolio should be in commodities because they are so volatile "” then you should just leave it in place and don't try to time things," said Holly Hooper-Fournier, editor of the Mutual Fund Strategist newsletter, which uses mutual funds to implement timing strategies.
"That's hard for the commodities investors who were late to the game," she added. "They did not have the benefit of the run-up of the last 12 months. They bought in recently because of the story, and now they're getting a timing sell signal, or they're just feeling the volatility because it's against them, and they want to blow up their strategy."
"The story is still, roughly, the same," said Walter Frank, chief investment officer for Moneyletter. "You are buying commodities on the premise that global growth ultimately will show up in demand for commodities, meaning that you will do reasonably well in the long run. The people who do spectacularly well playing commodities, well, let's just say that's not the average guy buying a commodities mutual fund. So if you've got a commodities fund, you play the fundamentals and try to ignore the ups and downs, no matter how spectacular those moves can be sometimes."
Ignoring the downs is never easy, as investors in commodities funds are finding out. In fact, those swings are readily visible in the performance charts, where Lipper shows the average commodities fund with an annualized gain of 16.4% over the last 24 months, but an annualized loss of 12.25% over the last three years. Over the last 10 full calendar years, the average commodities fund was up in seven of them, but the two biggest moves (both well over 30%) were to the down side.
"Ask yourself why you got into commodities in the first place," said Jeff Tjornehoj, senior research analyst for Lipper. "If you bought in because you felt your portfolio was not capturing the full market of securities, then you should have known that there is no free lunch and that the run would not go on forever. Backing away now would just re-open that hole in your portfolio. And if you have commodities in their proper place "” so that they are a smaller portion of your overall holdings "” there's just no reason to panic."
Chuck Jaffe is a senior MarketWatch columnist. His work appears in many U.S. newspapers.
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Chuck Jaffe is a senior columnist for MarketWatch. Through syndication in newspapers, his "Your Funds" column is the most widely read feature on mutual fund investing in America. He also writes a general-interest personal finance column and the Stupid Investment of the Week column. Chuck does two weekly podcasts for MarketWatch, and frequently makes guest appearances on television, and on radio shows across the country. He is the author of three personal-finance books. His latest, "Getting Started in Hiring Financial Advisors," was published in the spring of 2010 by John Wiley & Sons.
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