Swedroe: Don’t Count Out Commodities

March 12, 2018

The asset class with the worst performance over the past 10 years is collateralized commodity futures (CCFs). For example, from 2008 through 2017, PIMCO’s Commodity Real Return Strategy Fund (PCRIX) not only underperformed the Vanguard 500 Index Fund (VFIAX) by 13.7 percentage points, it lost 5.2% a year.

With that performance, many investors have concluded that the premise of investing in commodities was wrong, and that it was wrong to have invested in such a strategy. Before we go into a detailed analysis of the performance of CCFs, we need to discuss a few issues, beginning with the problem of judging decisions based only on outcomes.

Among the most common errors made by investors is to determine the quality of a decision based on the type of outcome. In his book “Fooled by Randomness,” Nassim Nicholas Taleb explained why this is a mistake: “One cannot judge a performance in any given field by the results, but by the costs of the alternative (i.e., if history played out in a different way). Such substitute courses of events are called alternative histories. Clearly the quality of a decision cannot be solely judged based on its outcome, but such a point seems to be voiced only by people who fail (those who succeed attribute their success to the quality of their decision).”

A good example of this involves thinking about life insurance. We buy it to protect against premature death. And we don’t complain about not collecting the premium. We also don’t judge the decision to buy life insurance a poor one because death did not occur. Yet when it comes to investing, we make this variety of mistake all the time. It just appears to be an all-too-common human error, and one influenced by hindsight bias—which is the tendency, after we know an outcome, to believe that it was inevitable.

Logic & Decisions
In her excellent book “Thinking in Bets,” Annie Duke cites the case of Seattle Seahawks coach Pete Carroll and his decision in the 2015 Super Bowl to have quarterback Russell Wilson pass from the Patriots’ 1-yard line, on second down, rather than hand the ball to human wrecking ball Marshawn Lynch, who had just gained four yards on the previous play, with 26 seconds remaining in the game and a chance to take the lead. The play resulted in an interception and headlines like this one: “Pete Carroll Botches the Super Bowl.”

But the facts are as follows. In 2014, rushes from the 1-yard line scored on just 57.5% of the plays, and Seattle had scored on just 33% of such plays that year. Even worse was Lynch’s success rate of just 20%. And over his three-year partnership with Wilson, Lynch had more often failed to reach the end zone (seven times) than he had reached it (five times) when given the opportunity from the 1-yard line.

And we cannot ignore that, in the NFL’s 2014 season, there were two fumbles on runs in that situation. As to passes, the league success rate from the 1-yard line was the same as for the run. However, there were no interceptions, or fumbles, in such situations. And Seattle had scored on half its tries. Without hindsight bias, also known as “Monday morning quarterbacking,” there is no way one could say that Carroll made a poor decision.

Another common error is recency—the tendency to overweight recent events/trends and ignore long-term evidence. This leads investors to buy after periods of strong performance—when valuations are higher and expected returns are now lower—and sell after periods of poor performance—when valuations are lower and expected returns are now higher. This results in the opposite of what a disciplined investor should be doing: rebalancing to maintain the portfolio’s asset allocation.


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