Target date fund managers who added commodities to their funds in recent months with the hope of diversifying their portfolios have made a startling discovery: Alternative investments continue to move in lockstep with the overall stock market.
“The sense I'm getting is that it wasn't so unexpected to see a spike in correlation during the crisis,” said Kathryn Young, a commodities fund analyst at Morningstar Inc. “What's unexpected is how long that correlation has lasted and how long it has been persisting.”
While commodities are typically added to portfolios for their tendency to move in the opposite direction of stocks, they — like most asset classes — were slammed during the market downturn of 2008. But the correlation between commodities and the stock market has continued.
Consider: The average commodity fund posted a return of -8.9% for the three-year period through Aug. 16, compared to -6.5% for the S&P 500, according to Morningstar.
Year-to-date, the average commodity fund had a -6.4% return, compared with -2% for the S&P 500 (See chart below for the year-to-date performances of three commodity funds versus the S&P 500).
Meanwhile, target date managers have been turning to commodity funds for diversification:
Fidelity Investments added the Fidelity Series Commodity Strategy Ticker:(FCSSX) to its target date fund series late last year; MFS Investment Management added MFS Commodity Strategy Ticker:(MCSAX) to its target fund family; and T. Rowe Price added its Real Assets Fund Ticker:(PRAFX) to its target lineup this summer.
So far this year, eleven commodities-driven funds have been launched, compared to eight in all of 2009, according to Morningstar.
“The challenge is, as the masses out there start to bring alternatives into the mix: Are they going to force the momentum for those alternatives to cut into the same direction as everything else?” asked Gerald Wernette, director of retirement plan services and a principal at Rehmann Financial.
Ms. Young added that the correlation between commodities and the equity markets has been largely driven by holdings in energy and base metals.
Some of the correlation may also be tied to a weakened world economy and poor investor confidence, said K. Geert Rouwenhorst, a professor of finance at the Yale School of Management and a partner at Summer Haven Investment Management, a quantitative investment manager of commodity futures.
“The increase in correlation is probably more of a general weakness in the world economy that reduces demand for commodities and places downward pressure on stock prices,” he said. Since many target-date funds keep only 1% to 2% of their assets in commodities, the impact of that correlation will be minimal, Mr. Rouwenhorst added.
John Ameriks, head of Vanguard Investment Counseling and Research, observed that the correlation between the equity markets and commodities has been increasing for the last five years. The company's target date funds don't participate in commodities, but its managed payout fund does.
“One attractive thing about commodities is that these are big, liquid markets, and it's very difficult to find other types of exposures that will be as straightforward to implement for sophisticated investment managers,” he said. “But you'll find as people look more at the risk out there and add them to their portfolios, it's inevitable that correlations will rise over time.”
