An Interview With Wesley Karger

November 05, 2007


Wesley Karger manages money for some of the wealthiest families in the world. He spoke with HAI about commodities.

  • An important part of all portfolios
  • Playing the “reflation” theme
  • Is China a bubble?

Wesley Karger manages money for some of the wealthiest families in the world. His firm, Twin Focus Capital Partners, is a multifamily office that focuses on building well-diversified portfolios that help clients preserve and consistently compound wealth. Karger’s firm focuses heavily on “alternative assets,” including commodities. He spoke recently with the editors of about the state of the commodities market. (HAI): Tell us about your investment strategy:

Wesley Karger, co-founder, Twin Focus Capital Partners (Karger):
We’re a true family office, so we literally look at investment opportunities globally across all asset classes. Generally, we categorize our investments into three broad categories: global equity, global fixed income and “alternatives.” Client allocations to the alternatives space can range anywhere from 10% to 15% on the low end all the way up to 50% or 60%, depending on client risk tolerance and overall objectives.

HAI: By alternatives, do you mean just commodities?

Alternatives are a catch-all category for anything that’s loosely or negatively correlated to traditional stocks and bonds. That includes hedge funds, venture capital, private equity, real estate and, finally, commodities. Our direct commodity-specific exposures run anywhere from 3% to 8% of client portfolios.

But that can be a little deceptive. We’re very cognizant of underlying exposures of the various strategies that we allocate to and the potential for correlation breakdown in the event of a shock to the system. Many of our managers, both long only and hedge fund manager, have overweights to the commodity sectors. Some of them may have exposures up to 20 to 30%. So even if we only have 3% to 8% direct commodity exposure, our portfolios could be underlying anywhere from 10% to 30% exposed to commodities and natural resources on a broader scale. This concentration has in part lead to strong absolute and relative performance of our portfolios in the recent past.

HAI: Why are you so bullish on commodities?

Our commodity investments are part of a larger theme that we have in our portfolios, which we call “reflation.” There are different silos in this reflation theme, but one of the silos is long commodities; the others include long emerging markets, short the dollar, etc.

We’re big commodity bulls. We think that the commodities story is still in its infancy, although, of course, there could be significant rain delays along the way to that success. Still, over the next five, 10 or 15 years we believe hard asset allocations will deliver solid returns.

The way we see it, the commodities story really has two legs to it. The first is strong global growth coming out of the emerging world. You look at countries like China and India, and those countries are consuming massive amounts of commodities due to their industrialization. We don’t see how that’s going to let up. The only caveat here is if we go into a consumer-led recession, commodity allocations will be hurt given the dropoff in demand.

The second leg of the commodities story is really the weak dollar. As I’m sure you know, commodities right now are priced based on the U.S. dollar. So as the dollar weakens, they become cheaper for non-dollar investors. We think these stories have a long way to go still.

HAI: What exactly do you mean by reflation?

: Inflation has begun being introduced back into global economy. And of course, one of the ways to protect against that in a portfolio context, at least historically, is through commodity allocations. Much in part because the volatility of commodities can vary significantly over time, with different inventory conditions and with differing regimes of monetary policy and business cycles. The low or negative correlation of commodities with stock, bond, and hedge fund indices indicate that have the potential to be very potent diversifiers of aggregate portfolio risk.

Something also adding to the commodities story is that big institutions, from public pension funds down to some larger single-family offices, are all really underexposed to the asset class. I think there will be profound changes brought about by the influx of institutional money in the space, specifically to the way we invest. There still is a perceived risk in commodity investment. Commodities on a stand-alone basis can be very risky, but when you combine commodities exposure in a portfolio context, it tempers that volatility, and the commodities come to act as a volatility buffer for your other investments.

: People have been talking a lot recently about commodities like gold becoming more closely correlated with the equity markets. Is that a concern?

: Gold is up over $810 an ounce and has become a hot-traded asset. We are cognizant of concerns about creeping correlations, because commodities have delivered equity-like returns during some periods of time. You see a lot of hot money, especially with the advent of new vehicles like ETFs. There are new ways for institutions and private individuals to access this space. That can boost prices, but also, being a little contrarian, it can mean that the potential diversification benefits and return enhancements are lost.

That’s why I say that there will be rain delays along the way, but longer term, I think the theme is intact.

HAI: How do you gain access to the commodities market?

: We’re really implementing our commodity exposure in three ways. One way is through passive ETFs; we may buy the GLD gold ETF or something else. We augment our exposures with active managers allocating to equity-based investments in natural resources companies. Finally, we operate in the hedge fund space. For clients that have the appropriate risk tolerance, we can take single manager positions with CTA managers; more often we use fund of funds.

Changing focus a little bit, let’s talk about China. China obviously has a huge role to play in the commodities marketplace. Are there concerns that China may be developing into a bubble?

: Over the past 24 months, China’s up 400%. There’s been a lot of speculation in the A share markets specifically. China this year alone is up 115%. We do think certain parts of the Chinese equity markets are in bubble territory right now. Still, we think that growth in the Asia region is going to be strong and offers some of the best risk-adjusted returns over the secular horizon. We also think there’s going to be a massive revaluation in the Asian currencies. Over the next 10 years, we could see revaluation of upwards to 50% in Asian currencies which act as an additional source of return being primarily USD investors.

HAI: So despite those concerns, you see the fundamental story for increased demand on commodities as intact?


HAI: And does that apply across the board, or are there specific commodities that are better positioned?

: I think it applies across the board over longer periods of time. I think the whole commodity market share will do very well, even markets you might not think of, like agriculture.

If you look at China moving from an agrarian society to more of an industrial society, you’re seeing massive amounts of people migrating from the rural towns and into the cities. As they do this, their wages pick up, and they work harder. And so, not surprisingly, they demand more protein. That’s one of the reasons why you’ve seen the price of pork skyrocket this year in China; because all the new workers are demanding more protein.

HAI: One asset class you haven’t mentioned that a lot of family offices do mention is timber. What are your thoughts on the timber market?

Karger: We don’t have specific allocations in any of our portfolios to timber, primarily because of liquidity concerns and the large minimums needed to access the best timber managers. Historically it has been a great asset class due to a combination of the use of the product as well as the real estate play, which is why institutions like Harvard at one point was reported to have a 10% allocation. However from a macro standpoint, it looks pretty rich here versus a few years ago.

HAI: Any other thoughts on the commodities markets? Anything else that the average investor should be aware of?

I think you have to understand the risks that exist. I think anyone that’s allocating capital, be it for institutional investors or for the ultra high net worth private client, has to be cautious about cross correlations. There are a lot of cross-currents in equity and commodity markets today, and prudent risk management is a must. But it remains a promising area of the market, and one that we remained focused on today.

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