Wednesday, May 21, 2008

PIMCO pimps commodities?

One of the best returning funds is PIMCO's CommodityRealReturn Strategy Fund A (PCRAX). It's up 25% YTD, and has 1, 3, and 5 year annualized returns of 44.32%, 20.41% and 18.52%.

This $15 billion fund, invests in highly rated bonds and TIPS and gets its exposure to commodities, according to it's prospectus: "This Fund will typically seek to gain exposure to the commodity markets by investing in commodity-linked derivative instruments, swap transactions, or index- and commodity-linked "structured" notes."

So you have the inflation hedge of TIPS, a six percent yield from the bond exposure and you participate in the upside of commodities.

And the fund's return is paid by the back of the average consumer who pays higher prices for food and gasoline.

Here's how and here's why we have such high commodity prices.

Demand for futures come from commodity consumers and speculators. Speculators buy and sell, but these commodity index hybrid funds just accumulate positions. They in effect hoard the commodities, causing the real users of them to pay higher prices.

And the fund investors make more money.

I highlighted a portion from their prospectus. There's a reason for that. The Commodities Futures Trading Commission (CFTC) regulates position limits in commodities, unless you are an Investment Bank hedging an over-the -counter swap transaction.

Thus the fund can get the commodity exposure while bypassing the position limits, and getting interest for the shareholders from the bonds backing the swaps. They win both ways.

And you pay the higher cost for groceries and gas.

The CFTC says that commodity and equity assets are non-correlated, thus commodity exposure provides diversification:

Diversification is the operative word here. It has driven the growth of hedge funds as a vehicle to provide investors exposure to commodity markets as well as adopt strategies that are uncorrelated with a publicly traded securities portfolio. Exchange traded futures and other derivatives that have been particularly popular with funds as a way to both speculate on and hedge market risks brought on by changes and uncertainty in the underlying marketplace.

We all know that when stocks get added to the S&P 500 they increase in price. What do you think happens when these funds hoard commodities?

So the next time Goldman Sachs shouts out $200 oil, they aren't only talking their book.

They're also talking the swaps they are selling!

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