As a group, the commodities complex was out of favor for much of the last decade. Now they’re back in style for two interrelated reasons: reflation and inflation.
The reflation trade is the au courant term to describe the expected surge in economic growth following last year’s Covid-induced financial crash. And because that upswing is heavily fortified by generous monetary and fiscal policies aimed at juicing the economy through ultra-low interest rates and large stimulus packages, many investors fear this added liquidity will create higher prices and accelerate inflation.
That’s an ideal backdrop for commodities, which are commonly viewed both as a go-to place during growth periods and as a hedge against inflation (not to mention that they are considered to be diversifiers against stocks and bonds).
The growth and inflation angles help explain the recent strong performance of the Parametric Commodity Strategy Fund, a roughly $760 million fund that gained 7.7% last year, which easily trounced its broad-basket commodities category average and landed it in the top quartile in its category, according to Morningstar. The fund had jumped nearly 44% in the one-year period ended April 12, besting the Bloomberg Commodity Total Return Index by about 12 percentage points.
But the fund’s performance isn’t just a flash in the pan—it has ranked in either the top half or top quartile in its category since 2014. Granted, some of that resulted from relative outperformance when commodities as a whole were drubbed and the fund beat the category even as it sported double-digit losses in 2014 and 2015.
Even so, the fund’s consistent outperformance speaks to its active management, which aims to differentiate it from the Bloomberg Commodity Total Return Index through a system of target weights and rebalancing bands designed to provide “rebalancing alpha.”
“The commodity asset class has certain characteristics that support a rules-based systematic investment process and portfolio construction techniques,” says Greg Liebl, one of the fund’s lead portfolio managers.
“Commodities have a well-earned reputation for high volatility levels, but they have low levels of correlation across the [various commodity] components,” he adds. “So if you look across the various commodity sectors, average correlation tends to be very low. Those are characteristics where diversification and rebalancing can help drive portfolio growth.”
Forecast Agnostic
Liebl says he and his colleagues at the fund don’t forecast which commodities will do better or worse, nor do they analyze supply and demand fundamentals or storage costs.
“We don’t take any active tilt based on forward-looking views,” he explains. “We’re reacting to the characteristics of the asset class and to the observations that passive indices in the commodity asset class tend to be highly concentrated. And that’s a problem if you’re coming to this asset class seeking broad commodity exposure and you get a passive solution that’s highly concentrated in energy.”
One of the ways the Parametric Commodity Strategy Fund differentiates itself against the Bloomberg Commodity Total Return Index is that it invests in 32 commodities, or nine more than the index (both the fund and the index take positions in individual commodities via futures contracts). That provides greater diversification across the asset class, Liebl notes.
“We include things in the portfolio such as tin, lead, platinum and palladium, which aren’t included in the benchmark index,” he explains. “They’re great diversifiers for our portfolio that add risk-reduction characteristics because they have low correlation to the other commodities in our portfolio. And that can potentially help with compounded growth rates over time.”
He adds that tin was up 38% in the first quarter. Again, that’s more about diversification—and fortunate timing—than an intentional market call by the Parametric managers.
Liebl says he and his team assign commodities to tiers according to liquidity conditions, and then equally weight them across those tiers. “We’re balancing competing goals: We like to be as diversified as we can, but liquidity doesn’t allow us to do that, and we balance that with a modified equal-weighted approach,” he says.
“But to harness the volatility and low correlation of the asset class, we establish rebalancing thresholds across the universe,” he continues. “As volatility causes drift in the portfolio, we rebalance back to our target weights to re-establish diversification and to potentially harvest rebalancing alpha in the portfolio.”
He notes that portfolio diversification and rebalancing are two core building blocks of the fund’s strategy. “That historically has enabled our strategy to outperform a more concentrated passive benchmark exposure,” he says.