A late New Year's resolution - Go alternative

Posted by: Aaron Pressman on January 17, 2006

This is my first blog post for Business Week and right at the top I’ll tell you that I encourage your feedback, either at the bottom of my entry or on your own blog. And though we’re obviously part and parcel of the MSM, we do have an industry-standard trackback list for every entry so you can get some link love back from us. The great strength of the blogosphere is the conversations that flow betwixt and between all the blogs. So please – if you agree or disagree or just have a question, bring it on.

That said and with the stock market in the tank today, thanks in part to higher oil prices, it’s a fine time to think about alternatives. Numerous studies have shown that the best way to invest over a long period of time is to diversify into different classes of assets whose performance isn’t closely linked. That smoothes out the highs and lows and leads to better average returns. So it’s time to get away from stocks and bonds for at least a portion of your portfolio. Here are some to consider for 2006:

First, there is Rydex Investment’s new euro-based ETF (symbol FXE). The dollar had a pretty nice run last year, with the start of the rally just about coinciding with Newsweek’s cover story “The Incredible Shrinking Dollar.” Oops. But I think there’s a pretty simple explanation for what happened last year. The rally also coincided with the market’s realization that Alan Greenspan wasn’t going to raise interest rates a little -- he was going to raise them a lot. Plenty of flow in the forex markets is just yield arbitrage, or more simply, money looking for the highest short-term rates of return. Now that the Fed has indicated it’s likely to go on hold soon – and at the same time other central bankers are looking at rate hikes – the dollar may be reversing again. The Rydex ETF is up almost 3% this year.

There’s a kind of new commodity-focused closed-end fund from Scudder trading under the symbol GCS. You didn’t buy it at the IPO last fall ('04), right? Please don’t do that! Now it’s trading at an 11% discount. That’s a pretty sweet way to buy shares of commod giants like ExxonMobil, BHP Billiton and Dow Chemical. But it’s hardly a pure play. Stocks of companies that produce commodities trade to some degree in line with the stock market – far more so that pure commodity prices – so this doesn’t play doesn’t capture as much diversification as some other ideas.

Coming down the pike soon from Deutsche Bank is an honest-to-goodness fund that will invest in a broad array of commodities. It’s an exchange-traded fund so no discount problems. Keep an eye out for it under the ticker DBC. It has by necessity a funky structure that relies on futures trading to gain exposure to everything the prices of crude oil, heating oil, aluminum, gold, corn and wheat. The management fee is expected to be 1.90% but interest income generated from its collateral will be about 2.50%. I’ll take a closer look once it starts trading.

For you mutual fund types, there are a few funds that invest in commodities, more or less. Pimco’s Commoidty RealReturn Strategy Fund (symbol PCRAX) invests in Treasury Inflation Protected Securities and derivatives based on the Dow Jones AIG Commodity Index. The fund gained 20% last year and an average of 21% over the past three. Most people either have to pay a steep front-end load or invest in a class of shares with high annual expenses (PCRDX). Still, the fund has largely tracked the index, doing a bit better when interest rates fall and worse when they rise because of the bond component.

In future, I’ll have more ideas along this vain – for now, talk amongst yourselves.

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About

Bloomberg Businessweek’s Ben Steverman focuses on the latest moves in financial markets and emerging trends in stocks, bonds, and funds, always with an eye toward giving readers a better understanding of the sometimes confusing and often chaotic world of money. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

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