Last month, the largest commodities fund in the world, the Pimco
Commodity Real Return Strategy Fund, fell more than 5 percent,
while the worst-performing broad commodities ETF fell slightly more
than 2 percent. What gives?
May was a rough month for commodities and bonds. Thankfully, ETF
investors only had to worry about the former. The bad news for
investors in Pimco's Commodity Real Return Strategy Fund (
) is the latter was perhaps even more important.
PCRAX-again, the world's largest commodities fund-currently has
more than $16 billion in assets under management, which is roughly
$5 billion more than is invested in all broad market commodities
Like the $6.44 billion PowerShares DB Commodity Tracking Fund
(NYSEArca:DBC)-the world's biggest commodities ETF-and the iPath
Dow Jones-UBS Commodity Total Return ETN (NYSEArca:DJP), PCRAX
tracks a diverse basket of commodities ranging from corn to Brent
As with the broad-market commodities ETPs, PCRAX aims to provide
investors with balanced exposure to the commodities complex and the
diversification benefits they provide.
Unlike these exchange-traded products, however, PCRAX is able to
invest cash collateral in all manner of credit instruments.
A quick look at the holdings list of PCRAX confirms this. As of
March 31, PCRAX held everything from Bear Sterns Adjustable Rate
Mortgage Trusts to Petrobras corporate debt to Mexican sovereign
bonds. In fact, the bulk of the fund's $16 billion asset tally is
invested in TIPS, and the portfolio has an effective maturity and
duration of six and 4.6 years, respectively.
To be fair, this isn't news. The fund's home page plainly
states:"The fund seeks to capture the performance potential of a
commodities index backed with a portfolio of Treasury
Inflation-Protected Securities (
), offering broad participation in the return of commodities while
harnessing Pimco's innovative Double Real approach."
That "Double Real" approach effectively means investing
collateral in securities other than three-month Treasurys. Said
another way, whereas
like DJP and the United States Commodity Fund (NYSEArca:USCI)
invest collateral in ultra-short-term Treasurys, PCRAX takes
everything from credit to currency to duration risk with its
What is news, however, is how this approach impacted returns
during a period where commodities and bonds fell in price. The
chart below shows the performance of PCRAX along with those of
widely followed commodities benchmarks.
As you can clearly see, yields rose across the board in May,
punishing bondholders. While there were certainly pockets of the
market that performed better than others, the weakness in the bond
market was systematic.
When commodities prices and bond prices are rising in lock step,
this flexibility-if you would like to call it that-can be a boon to
investors. When the opposite is true, it can punish investors.
All of this is to say that PCRAX, like many strategies that
provide this type of collateral optimization, are leveraged
products that aren't labeled as such. After all, if ETF managers
wanted to invest cash collateral in Mexican government bonds or
Fannie Mae agency debt, the Securities and Exchange Commission
would force the ETF issuers to amend their prospectuses.
None of this is to say that Pimco is necessarily misleading its
clients. It lays out all of the risks of this strategy in the
requisite legal documents and clearly displays its holdings for all
to see. For their purposes, they have provided full disclosure.
It's therefore a matter of perception and how one defines
leverage. When you hold a commodity ETF, the requirement is that
all cash collateral be invested in cash or cash equivalents.
Any departure from this, by definition, represents the
introduction of leverage. Meanwhile, PCRAX invests 100 percent of
its portfolio's collateral in a wide range of debt instruments,
none of which expires less than a year from now.
Why then doesn't anyone call PCRAX a leveraged fund when it's
clear the collateral in the portfolio is exposed to everything from
default risk to geopolitical risk? Considering that most people use
commodities and the products that aggregate them as a means to
diversify away from credit and equity exposure, why would they want
to invite these risks into the commodity portion of their
We all know Pimco is the most respected bond manager in the
world. I'm not questioning its ability to manage the collateral
effectively and navigate the various risks of investing in the
various debt instruments they currently hold in PCRAX.
What I am questioning is why more people don't view PCRAX as a
leveraged commodities play given the laundry list of risks the
portfolio takes on above and beyond those provided by the basket of
commodities futures contracts it holds.
I guess it's just another example of why I love ETFs.
At the time this article was written, the author held no
positions in the securities mentioned. Contact Paul Baiocchi
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