Investors’ Risks Higher in Commodity Funds
Commodity funds, a way for small investors to play the wild and woolly game of futures-market speculation, have gained popularity recently thanks to sharp run-ups of some funds, predictions of higher commodity prices and disillusionment with stocks.
But the funds--which generally are limited partnerships sold through stock brokerages that invest money in various futures markets--are not for faint hearts. Their performances are extremely volatile, and at least two have suspended trading so far this year, after losing much of their investors’ money in poor trades.
Like direct investing in futures, they should be approached with great care, and only with money you can afford to lose.
“Commodities in general are a risky proposition, and there is nothing less risky about commodity pools,” says Michael Crowley, staff attorney for the National Futures Assn., a self-regulatory organization of broker-dealers. The added diversification provided by the funds “doesn’t turn them into conservative investments,” he says.
Nonetheless, the funds have more than doubled in assets in recent months. Assets of the 127 publicly offered funds--although puny in comparison to mutual funds--have grown to about $1.6 billion from $650 million at the end of 1986, according to Managed Account Reports, a Columbia, Md., newsletter that tracks commodity funds.
One attraction of the funds is that they often gain when stocks and bonds do poorly. Such was the case last year, when eight commodity funds posted profits of more than 100% and all of them gained an average of 40.2%. The funds have posted an average annual return of 12.3% since 1979, after costs and fees, according to Managed Account Reports.
Another attraction of the funds, compared to direct investing in commodities, is that they allow you to invest relatively small amounts, usually as little as $5,000. Those monies go into a pool with other investors’ money that professional managers then invest in a diversified mix of futures contracts.
These contracts--which are agreements to buy or sell a set amount of a commodity at a set price on a given day--are essentially bets on the future price movements of anything from orange juice and gold to Treasury bonds and the Standard & Poor’s 500-stock index.
Individual investors often are at a disadvantage against professionals when playing futures markets directly, partly because they can’t trade quickly enough and lack information about news events, such as changing weather conditions, that can move markets.
Also, publicly offered funds marketed by reputable brokers generally run honest operations and aren’t subjects of the volumes of investor complaints and swindles rife in certain other commodity-oriented investments, says Crowley of the National Futures Assn.
To make profits, the funds don’t necessarily need commodity prices to go up. They can bet that prices will fall as well as rise.
“What most of them need are good trends, big movements either up or down,” says Jay Klopfenstein, president of Norwood Securities, a Chicago brokerage that tracks commodity funds.
Last year, for example, was a good year because of strong movements in silver and gold, foreign currencies and Treasury bonds, according to Morton Baratz, editor of Managed Account Reports. The 40.2% gain for 1987, however, followed a 12.7% decline in 1986.
Through the first four months of this year, funds were down an average of between 12% and 13%, but in recent weeks they have been rebounding, thanks to strong rises in soybeans and other commodities, Baratz says.
Some funds have done far better--or far worse--than the average. The top performing fund in 1987, the Tudor Futures Fund, gained a whopping 201%, thanks in part to timely trades on futures of stock indexes and Treasury bonds before and after October’s stock crash.
On the other hand, two relatively new funds managed by wealthy Chicago futures trader Richard J. Dennis, called Dennis I and Dennis II, halted trading in the past two months after losing about half of their investors’ money. They may resume trading at some later point.
With such risks, “you should only invest money in commodity funds that you can afford to lose,” newsletter editor Baratz says. Some advisers say investors should place no more than 10% or 15% of their investable monies in commodities or commodity funds.
There are other drawbacks to these investments besides volatility.
Most commodity funds, unlike conventional mutual funds, are available for new investment only for a limited period after starting, often about 90 days. After that, they are closed for new contributions. Only about 20 publicly offered funds are currently open to new investors.
Also, brokers may only sell the funds they underwrite, which aren’t necessarily the best performers. So you will have to shop around.
Selling your shares can be a hassle. You generally can get out only at the end of each month, following written advance notice, usually two weeks before the end of the month. If you miss that deadline, you may have to wait until the end of the next month before cashing out.
“In the meantime, you don’t know whether your fund will go up or down,” broker Klopfenstein says.
Another drawback: High fees and expenses. Most funds charge sales commissions, often about 2.5%. And because they rely on frequent trading, the funds’ annual management fees, commissions and other expenses average about 18% of the amount invested, Baratz says. That is far higher than expenses of 1% to 3% that are typical of stock and bond mutual funds.
With such high expenses, “a fund manager has to get a 30% gain in trading to produce a net return of 12%,” Baratz says.
Still interested in investing? If so, be sure to thoroughly examine the track records of fund managers. Be wary of new ones who haven’t traded for at least several years, Klopfenstein says.
Unfortunately, tracking performance is not easy because funds generally aren’t listed in newspapers and few analysts follow them. To track performance and get a list of funds, check with your broker (although most probably know little about commodity funds), or subscribe to Managed Account Reports (5513 Twin Knolls Road, Suite 213, Columbia, Md. 21045; 301-730-5365).
Ask for its $50 quarterly report, which contains information on performance and fees. Also ask for its free brochure, “Guidelines for the Selection of a Commodity Money Manager.”
You also can obtain information about fund managers through their prospectuses. Baratz suggests writing to trading managers and asking them to send disclosure materials. “If they refuse to do so, that’ll tell you a lot,” he says.
