Legendary investor says stability of weightings, broad list of commodities give true reflection of the cost of doing business.
All commodity indexes are not the same. But what are the differences between the S&P Goldman Sachs Commodity Index, the Reuters/Jefferies Commodity Index, the Dow Jones – UBS Commodity Index, the Rogers International Commodity Index, the UBS Bloomberg CMCI Index and the Deutsche Bank Liquid Commodity Index? Hard Assets Investor continues its ongoing series examining how the major commodity indexes work by interviewing the people and discussing the strategies behind them. In this installment, Managing Editor Drew Voros caught up with legendary investor Jim Rogers, who created the Roger International Commodity Index in 1998.
Previous “Behind the Index” interviews:
Hard Assets Investor: Why did you create the Rogers International Commodity Index?
Jim Rogers: At the end of 1998, I thought the bear market in commodities was coming to an end. I wanted to invest in commodities. So I decided what I’d do is just invest in a commodity index. But then when I went and looked at commodity indexes, they were all so horrible that I couldn’t bring myself to put my money into them.
HAI: When you say “horrible,” what do you mean?
Rogers: For instance, at the time, the Goldman Sachs [Goldman Sachs Commodity Index] was about two-thirds energy. I said, “Gosh, what kind of index is that?’ You might as well invest in oil. More important, they change the index every year. You have no idea what you’re going to own if you invest in the Goldman Sachs index. In my book, “Hot Commodities,” I have a study which shows the dramatic changes in the Goldman Sachs index.
For instance, one year something’s 26 percent and a few years later it’s 4 percent. I said to them, “How can anybody invest in that? If I invest in the Goldman Sachs index, I have no idea what I’m going to own in three or four years. And you don’t either.” This is my money I’m talking about, I’m not talking about clients’ money. And as you know, Goldman Sachs used to have extensive arbitrages against its own customers. I didn’t have any customers. And I wasn’t interested in arbitraging against customers; I was interested in investing my own money. So I eliminated that one.
I then went to Dow Jones. I happened to go to college with a guy, Paul Segal, who was running The Wall Street Journal at the time. I said, “Paul, I want to license your commodities index.” And he said, “We don’t have a commodities index, Jim.” So I pulled out The Journal and showed him the Dow Jones Commodities Index. They later got in bed with AIG and updated their index. Then a few years ago sold it over to UBS. The index changes all the time. There are things in there like aluminum, which is weighted more important than wheat. Some people in the world had never seen, much less used, aluminum. Everybody uses wheat.
Then there’s the RJ/CRB Commodity Index that has changed 10 times in its history. At the time I was looking, they had orange juice and crude oil as the same weighting. In most people’s lives, crude oil is a whole lot more important than orange juice. I wouldn’t put my money into any of them. I had to come up with my own index, which has beaten the socks off all of the others. Equally important, mine has been stable and consistent. The changes have been de minimis in the Rogers Index since it started in 1998. Those others change all the time. I don’t know how anybody could have conceivably invested in them. That’s not even gambling. At least with gambling you know how many cards are in the deck. But with these other indexes, it’s not even random. It’s totally unknown what you’re investing in. That may be one reason that I’m beating the socks off the others.
HAI: You do change the index under extraordinary circumstances according to your filings. When was the last time it was actually rebalanced and why?
Rogers: There have been small things. Something may go from 20 basis points to 10 basis points or something like that. It’s mainly because of liquidity. We might have a slight change in one of the agricultural components, but we take it away from one component and add it to another agricultural component, which is comparable.
I noticed in one of your previous stories that other index guys were trying to take a swipe at my index, by saying everything in their index was a significant percentage. I would remind that person that the S&P 500 has 20 components which have 1 basis point, one one-hundredth of a percent. So if he thinks that small components should be dropped, he’s fighting the world. As far as I know, the S&P 500 is the most extensively known and used index in the world.
I wanted my index to be international. I wanted it to reflect the cost of doing business around the world. I wanted it to be broad based. None of the other indexes has rice, for instance, even though two-thirds of the people in the world eat rice every day.
The other problem I found with the others is that they’re U.S. centric. At the time I was looking for an index, most of them wanted to reflect what was going on in the time zones where they were working. They had U.S. and U.K. components, so that it’s easier to arbitrage against their customers, or just to compile the index. This was long before computers were so extensive. Now, of course, that doesn’t really matter very much.
And of course you have to consider liquidity. It doesn’t do you any good to have an index which is just academic. You’ve got to be able to use it.
HAI: Why is human intervention to you more important than a rules-based index?
Rogers: The Dow Jones industrial average or even the S&P 500 are “human intervention, human judgment,” if you will. In my view, if you want to have stability and consistency in transparency, I’d prefer a system which we have developed. It stood the test of time.
The consumption of cotton doesn’t change that much over any long period of time. Maybe there are ups and downs. But you don’t change the weightings because cotton goes up one year or down another year. Look at the Goldman Sachs Index. If something goes up in price, the index increases the weighting. That’s the way my mother invests.
My mother calls me up and says, “I want you to buy X,” and I say, “Why?” And she says, “Because it’s tripled.” I say, “Mother, you’re supposed to buy it before it triples.” Goldman Sachs and UBS and the rest of them raise the weighting when prices rise. Listen, I’m an investor. This is my money. I know what people need if they’re going to invest. And they don’t need some gimmick to attract investors. They need something where they’re going to make money.
HAI: Explain how the consumption weights are calculated.
Rogers: You have to weigh consumption with liquidity. While two-thirds of the people in the world use rice every day, you couldn’t have that kind of weighting in the index because the exchange trade of the rice market is not deep enough.
Without a public market, obviously you cannot have rice with its proper weighting. Therein lies the conundrum. You have to weight liquidity with consumption. Germany and Vietnam, for instance, both have about the same population. But Germany is northern, with seasons, and very industrialized and has lots of cars. Vietnam is more southern, with very little industrialization and very few cars.
But if you’re going to have something to reflect the cost of moving around the world, you’ve got to balance, and that’s hard. That’s why you cannot just use pure consumption as much as I would like to, or use consumption for Vietnam of rice, or consumption of Germany for rice.
HAI: What kinds of futures contracts are tied to the index?
Rogers: The contracts that are in this index trade on the public exchange somewhere.
When I was starting the index, I went to the folks at the Journal of Commerce Index, for instance, which included things like hides and tallow. I said, “Well that’s wonderful, but you’ve got to have something with public visibility. I don’t want to have to call up 16 guys to find out the price of hide.” It’s got to trade on a public market to ascertain the liquidity and the actual price. So everything in the index trades on a market somewhere. And by the way, these things have a habit of getting more liquid. Crude oil, for instance, didn’t trade on exchange at all, until the 1980s. And now of course it’s the most traded of any commodity.
We only invest in the second-nearest month. This is designed to be a pure reflection of commodity prices. The only way you can do that is to use the spot month, but obviously you can’t use the spot month because you’re subject to delivery or various kinds of distortions. So I had to use the second-nearest contract as the closest reflection of the actual cost of doing business.
This was designed to be a pure, simple index. It was not designed to be actively managed in any way. Index investing outperforms 70 or 80 percent of active managers year after year after year. There are plenty of people to confirm that; it’s not coming from me.
HAI: How much capital is tied to your index?
Rogers: I’ve asked my office not to let me know. It’s a little bit like my books. I told the publisher not to show me how many copies I’ve sold, because I’m afraid I’ll jinx it.
I will say that this index is not nearly as used as the others, partly because I’m not Goldman Sachs. I don’t have thousands of salesmen out peddling my index. That’s a shortcoming. I’m thinking about a way to somehow try to improve that shortcoming. Because as I’ve said before, intellectually it’s the best constructed index; performancewise it’s the best-constructed index. And all the ones who try to take pot shots at it are pretty simple-minded, like the other index guys who say, “Oh we don’t have small weightings of anything.” To repeat, they should look at the S&P 500 and lots of other indexes too, which are successful with very small weightings.
HAI: In terms of general commodity investing, what are some of the mistakes that you see investors commonly make?
Rogers: They make the same mistakes investing in anything. They use too much leverage. The great advantage of commodity investing is you can use enormous leverage. The great disaster of commodity investing is you can use enormous leverage. Everybody in the world has a story about a brother-in-law who went broke investing in soybeans. But you don’t have to invest that way. When I set up the original fund, the point was to use no leverage so that the index and the fund would give a reflection of the cost of doing business.
But the main mistakes are just what people make in everything. A lot of people invested in dot-coms, but they had no clue what a dot-com was. People bought dot-coms on enormous leverage having no clue what they were doing, not understanding the risk of leverage and knowing little about dot-com businesses.
HAI: Do you think the introduction of ETFs minimized some of those mistakes?
Rogers: Well, as far as I’m concerned, ETFs are a wonderful thing. It makes life easier for a lot of people. It minimizes your tax consequence. If you invest in a mutual fund, your expenses are higher; because the portfolio manager is always buying and selling, you have tax consequences. ETFs are much, much better. There are ETFs that use all sorts of wonderful financial engineering, which I’m sure I wouldn’t understand. But I don’t bother with them. As long as you’re just investing in a simple ETF that doesn’t have a lot of financial engineering, I think they’re wonderful. But even the ones with the financial engineering, if they’re done properly, fine. It’s like any fund that’s got financial engineering: As long as they know what they’re doing, it’s fine.