Investing In Commodities Without Leverage

June 12, 2013

Who knew the world’s biggest commodities mutual fund was a leveraged play, and who knew the world’s biggest commodities ETF isn’t?

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 (PCRAX) 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 ETPs combined.

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 crude.

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 (TIPS), 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 ETFs 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 collateral.

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.

Indexes Performance


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