1. 1 XVIII. Publicly Traded Commodity Funds

2. 2 Publicly Traded Commodity Funds Private partnerships offered by prospective: 1.Most funds have the ability to trade (and do trade) in many futures and forward contracts on financial instruments, foreign currencies and commodities. In addition, they frequently hold financial instruments directly (using them for margin against their futures transactions). Most fund prospectuses stress diversification and the ability to take long as well as short positions in commodities (i.e., to buy or sell futures contracts). 2.Most funds can only be purchased for a short time after the initial prospectus, but allow investors to liquidate their position at net asset value at monthly (sometimes quarterly) intervals. A monthly rate of return can, however, be computed. 3.Most funds use technical and trend following systems to decide whether to take a long or short position with respect to any commodity (futures contract).

3. 3 4. Most funds incur high management fees and transaction costs relative to other types of asset management such as mutual funds. Management fees usually exceed 5 per cent of capital a year, while the sum of management fees and transaction costs exceeds 19 per cent of capital per year. 5. Most fund prospectuses contain a clause that calls for the fund to dissolve if either the net asset value per share falls below a predetermined level (most often 25 to 30 per cent of the initial capital an investor pays in) or the total size of the fund (assets under management) falls below a specific level.

4. 4 Typical quote from prospectus “Trading decisions of the Advisor will be based primarily on technical analysis and trend-following trading strategies which seek to identify price changes and trends. The buy and sell decisions based on these strategies are not based on analysis of fundamental supply and demand factors, general economic factors or anticipated would events.”

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6. 6 Data – monthly returns July 1979 – June 1985 latter updated through 1988 (second study) Problems in date – managed account reports Ending returns Surviving bias – assumed reinvested in surviving funds Latter assumed reinvested in T-bills

7. 7 ValueReturn June601 July88146.6 August9548.3 September161769.5 October183413.4 November19023.7 MHR28.3% December254-86.7 MHR9.1% GHR-13.43%

8. 8 THE PERFORMANCE OF PUBLICLY-TRADED COMMODITY FUND A.AS A STAND-ALONE INVESTMENT B.AS PART OF A PORTFOLIO OF STOCKS AND BONDS IDENTIFYING (PERDICTING) SUPERIOR PREFORMING FUNDS. CONCLUSION

9. 9 Year# of Funds ReturnStan. Dev. 112.0027.1577 216.0090.1211 334.0112.0824 449-.0267.1167 570-.0054.0793 685.0048.0943 Average-.0007.1130 Average Monthly Returns Based on Annual Holding Period June– July

10. 10 Avg. Monthly returns (based on 1yr HP) S.D. Monthly Returns Commodity Funds -.0007.1130 Small Stocks.0123.0639 Common Stocks.0074.0414 LTC bonds.0045.0271 LTG bonds.0041.0279 Treasury Bill.0051.0026 266 fund years 49% negative 61% below T-bills

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12. 12 Approaches 1.Average each years standard deviation – ignores more funds (observations later years). 2.Average each funds standard deviation – ignore over counting common variance later years. 3.Estimate the systematic and non- systematic component of standard deviation separately.

13. 13 Recall from lecture on International Stocks to put any money in commodity funds P = portfolios of stocks and bonds

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16. 16 This date suggests that commodity funds must earn about 9% a year to be considered a good candidate for inclusion in a portfolio of stocks and bonds. Recall that investments in futures is a zero sum gain – return from buyer + return to seller = 0 (less transactions costs) Funds fees average 19% per year Management must have information worth 28% per year to produce this return. Evidence from other capital markets make this unlikely.

17. 17 Funds bad on average but can we use information to pick good funds Weak predictability in Sharpe Ratio. Virtually no information in past returns Fair amount of information in past standard deviations

18. 18 If performance is bad why do investors purchase. Two explanations. 1.Markets are irrational 2.Investor receive biased information. Sucker born every minute. Can’t evaluate inaccuracy. Important consideration – no way an informed investor can trade against to make an arbitrage profit. If an informed investor can not benefit from an overpriced asset all we need for it to exist is enough uninformed investors.

19. 19 Sources of Information a)Prospectuses b)Press Coverage Prospectuses – acquired 79 of the 91 funds in original sample – Prospectuses Return minus Public Fund returns same month = 2.81 Value of 5.15

20. 20 What went wrong? 1.Transaction costs and management fees 2.Self Selection bias 3.Control over reported #’s 1.Transaction Costs and Management Fees Public funds often have higher management fees and transaction costs than private accounts. 23 prospectuses estimated change in fee. From these number average returns in prospectuses would be lowered by.13% from 5.59 to 5.46. Doesn’t account for much.

21. 21 2. Self Selection There were 2080 registered commodity trading advisors. Only about 10-15 went public each year. If the mean was zero given the standard deviation more than 40 a year should have return above the 5.59% reported. Select good past record bring public – This has implications for all private partnerships. 3. Control over reporting numbers Must report 36 months if such data exists – can report more a) return in 36 month = 4.14% per month b) in extra months 8.85% per month c) in starting month 14.6%

22. 22 Other source of information – the popular press Looked at 34 business magazines Looked at Wall Street Journal and New York Times (8 articles) Almost all were favorable many discussing the spectacular results of some particular manager. Even the article that is not favorable often contains details on one successful fund. Typical is April 26, 1982 article in Business Week. After explaining that half the funds in the industry suffered losses in 1981, it explains the industry is continuing to grow probably because of the outstanding performance of some funds and then discusses in some detail the performance of Heinhold which earned a 75% rate of return in the previous year.

23. 23 Why do the funds exist and continue to exist? 1.Biased information 2.Limited experience of any investor 3.No way that an informed investor can trade against them – all an informed investor can do is not buy.