Adding Alternatives to your allocation
Readers here would have noticed that I do have much info here dedicated to commodities, gold or energy in my weblog. This is because going forward, these alternatives have a huge potential to provide that alpha growth for your portfolio.
Alternatives as an asset class
Critics of commodities would point to the 20 barren years where they go nowhere and give negative returns annually. However, it has become an asset class that cannot be ignored going forward.
Like REITs, it provides a low correlation to normal equities and bond price movement. In fact, the correlation of commodities and gold tend to be negative compared to equities. This means that when the price of equities are going up commodites are likely to head in the opposite direction.
But don’t take it that it is always the case. Chances are the easiest way that you get expose to commodities and gold are through unit trusts that invest in companies that deals with commodities and gold mining companies. since they are equities, at times they are subjected to the same systematic risks that affect the general equity market.
A good way to illustrate how a different correlation impacts your basic equities/bond allocation is illustrated below, which i taken of hardAssetInvestor:
Let’s look at the data on a decade-by-decade basis (you build your portfolios to last decades, don’t you?). We’ll call a portfolio consisting of 60 percent stocks, represented by the S&P 500 Index, and 40 percent bonds, depicted by the Lehman Brothers Aggregate Bond Index, the "Basic Portfolio." A mix of 45 percent stock index, 40 percent bond index and 15 percent our hard assets benchmark will be dubbed the "Augmented Portfolio."
Effect of Augmenting Portfolios With Hard Assets
Augmented Portfolio
Basic Portfolio
Decade
Annual
ReturnStandard
DeviationReward
to RiskMaximum
DrawdownAnnual
ReturnStandard
DeviationReward
to RiskMaximum
Drawdown
1970s
8.1%
12.3%
.66
-25.2%
5.6%
15.2%
.37
-42.7%
1980s
14.9%
11.0%
1.36
-18.5%
15.7%
12.0%
1.31
-20.7%
1990s
13.3%
8.5%
1.56
-10.9%
15.0%
9.7%
1.57
-11.7%
2000s
5.8%
7.2%
.81
-9.4%
3.5%
6.8%
.51
-17.1%
Source: Van Eck Research.
The numbers seem to indicate that a constant allocation to hard assets provided a better reward-to-risk proposition for most of the past three decades compared to holding stocks and bonds alone. Most important, the smaller drawdowns in the hard asset-augmented portfolio shows the dampening effect of the asset class on stock and bond market swings. That should allow the portfolio holder a better chance to recover from downturns and retain more of the gains earned in upswings.
Fundamentals of Alternatives
With regards to fundamentals, whats going for commodities,gold and energy is a list of factors:
- Rising world population spurs the demand for raw materials and food
- Rising affluence for precious metals
- Mass printing of money by countries all over such that there is demand for hard currency
- Oil production declining and the slow progress of finding alternative efficient energy sources
- biofuel and ethanol demand fighting with food & agriculture as a food souce
With the host of positive factors for commodities, it is appropriate that we plan ahead and be forward looking in our allocation.
More info on the fundamentals of alternatives can be found here in my blog under Gold and Commodities and Contrarian.
My Allocation
How much to allocate to this segment? The textbook answer ranges from 10% to 15% of your portfolio, but i intend to horde 20% of my allocation into this segment.
Currently, i have only 7% into this. Slowly, part of the cash portion will go into this. Below is what i am currently invested in for this category:
Recent additions (during the mid highs last month, arghhhhhh) are the GLD ETF which is an exchange traded fund that is backed by gold bullions traded on the NYSE. However, for Singaporeans, you have access to it on the SGX. Recently, it has been CPFIS approved, although it is considered as a gold investment instead of stocks, which means that you can deploy at most 10% of your CPF into it.
There is also Penn West Energy (PWE), which is a Canadian Energy Trust (CANROYS) listed on the NYSE. What i like about PWE is that it gives me an exposure and diversification into energy, provides a div yield of 8% (based on current price and current operating cashflow, the yield is 14%. but i’m adjusting it to factor in a 30% div tax). I will be writing abit on CANROYS in the future. Do take note that i dun see this as a dividend play like some of my stocks but basing yield as a factor for determining value of a company.
This stock has been beaten down due to dilution of shares after purchase of Canatic, the SIFT tax that comes into effect after 2011 and the recent correction in energy prices.
Some Charts
ADX for Penn West looks to be turning, we might see a short term bottom in the draw down for PENN WEST next week. Still can’t believe its 8% down for me at an entry price i deem low.
Goldcorp is a stock that i am interested in. However, together with GLD, the mining sector seems to be searching for a bottom. I am disgusted with my timing of entry, but if it falls further it presents an opportunity to add further.
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