An Interview With Brad Zigler

October 15, 2007

The former head of education and research at BGI considers ETFs, commodities and the "commodities bubble."

  • ETFs: Best thing since sliced bread?
  • Risk in the ETN market?
  • Finding alpha in commodities

 

Brad Zigler brings a rare talent to the field of investing. The former head of marketing, education and research for the Pacific Exchange and Barclays Global Investors has emerged as the “funny man of finance,” combining sharp analysis with a biting wit to bring the financial universe alive.

A regular contributor to theStreet.com, Institutional Investor, CRB Trader and Registered Rep., Zigler spoke recently with the editors of HardAssetsInvestor about the current state of the commodities market … and what investors should look for in the commodities space …

HardAssetsInvestor.com (HAI): How has the commodity market changed in the last five years?


Brad Zigler (Zigler):
Significantly. You have far more people investing in commodities than ever before.

(Zigler): I think the single biggest change is the advent of exchange-traded funds and exchange-traded notes. For the first time ever, individual investors are able to access commodities at a reasonable price and with good liquidity.

There have always been ways to get into the commodities market: managed futures, commodity pools, public funds and commodity stocks. But none of them offered pure exposure to commodities at a low cost. And if that’s what you’re looking for, the current crop of ETFs and ETNs is unmatched.

HAI: How should investors choose between all the different ETFs, ETNS, TRAKRs, etc.?

(Zigler): Liquidity is a primary concern; you have to be able to get in and get out of a position. The problem with commodity-based mutual funds—aside from costs—is this: If someone wants exposure at 10 a.m., they can’t get it. They can put in an order but they won’t get filled until 4 p.m. The commodities market moves fast, and some investors—particularly technically minded traders—can’t have that kind of delay.

You also need transparency to be able to understand and accurately price what you own. And the ETFs and ETNs offer that.

HAI: Should investors be concerned with credit risk in the ETN market?

(Zigler): There’s a whole school of thought about “six sigma” events. We often act as if certain events are so remote as to be virtually impossible. But we’re constantly reminded that probabilities are just that —probabilities that can become realities. Lately, it seems like “once-in-a-hundred-year” events take place almost every week. We all know what happened at Barings Bank. That’s not to say that BGI [sponsor of the iPath ETNs] will likewise face disaster, but it can’t be ruled out entirely.

All that said, I personally feel comfortable using the ETN format, particularly in taxable accounts.

HAI: We’ve seen a huge inflow of assets into this market. Has that changed the dynamics of the market? Has it created a bubble?

(Zigler): In the long run, I think these things will balance out. Is the rush of money into the space having an impact? Possibly. But these are large markets, and the money will flow where it finds returns. In the end, I don’t think it’s such a large problem.

If you think about the role commodities ought to play in a portfolio, they’re hedges with low correlations to equities and fixed-income. So even if a commodities component itself is risky, over the long haul, the data show that having commodities in your portfolio reduces your overall risk.

HAI: Morningstar came out with commodity indexes that pair long and short positions. Should investors consider those? Is there alpha in the commodities market?

(Zigler): Alpha is never easy to find. That’s true in stocks, and it’s true in commodities.

But I do think there’s something to the Morningstar approach. To get the true benefit of commodities, you should think about how endowments like Yale University invest in the asset class. Endowments are among the most successful commodity investors out there. The folks at Yale aren’t taking long positions in a passive index; they have managed accounts that combine short and long positions.

Having the flexibility to go short in a commodities account offers the full benefit of the asset class. From an index point of view, the Morningstar indexes are interesting … it just remains to be seen how they do in real time. I’ll be anxiously awaiting the launch of ETFs tied to those benchmarks, and will closely monitor their performance if and when they begin trading.

HAI: What should investors keep in mind when investing in the commodities market?

(Zigler): You have to remember that commodities trade in a risk transference market. It’s not like the equities market.

Stocks exist so companies can raise capital. The commodities market is different—it’s designed to shift risk from commercials to speculators.

The big players in commodities, then, are the users and producers of the stuff itself—not just investors. These users have real needs that create a number of dynamics including seasonal patterns, contango/backwardation and others. Commodity investors need to understand these factors before they start trading this asset class.

There’s a difference, too, between investors and speculators. You might think of speculation as a “one-off.” It’s opportunistic and short term. Investing is all about long-term exposure to the risks and rewards of the asset class.

There has been tremendous coverage recently about the great commodities boom. Investors need to remember that the real role of commodities is as a diversifier in a smart asset allocation.

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