Mostly Voices [0:00]

A foolish consistency is the hobgoblin of little minds, adored by little statesmen and philosophers and divines. If a man does not keep pace with his companions, perhaps it is because he hears a different drummer. A different drummer.

Mostly Mary [0:18]

And now, coming to you from dead center on your dial, welcome to Risk Parity Radio, where we explore alternatives and asset allocations for the do-it-yourself investor. Broadcasting to you now from the comfort of his easy chair, here is your host, Frank Vasquez.

Mostly Uncle Frank [0:37]

Thank you, Mary, and welcome to episode 99 of Risk Parity Radio. Today on Risk Parity Radio, we are going to analyze a commodities fund using David Stein's 10 Questions to Master Investing, as we always do for these sorts of things.

Mostly Voices [0:58]

Yes! And so we'll just get right to it.

Mostly Uncle Frank [1:01]

Question one, what is it? Well this is the Direxion Auspice Broad Commodity Strategy ETF and it has the ticker symbol COM. And what it is is it seeks to provide investors with an opportunity to take advantage of rising commodity prices In addition to mitigate risk by going flat into cash when individual commodities are experiencing downward trends, it seeks to potentially provide commodity investment returns with lower risk characteristics than long-only commodity strategies. It has exposure to 12 commodities, which include soybeans, corn, wheat, cotton, sugar, Crude oil, natural gas, gasoline, heating oil, copper, gold, and silver. And it is structured in such a way to follow an index, but it only buys the commodity when it is in a positive trend. And then when the commodity goes flat or falls, it goes to cash in that particular commodity. So for instance right now commodities are going up or they were as of March 31, 2021. I'm looking at this fact sheet here, which I will link to in the show notes, and it shows that this fund is currently long all of those commodities except for natural gas and gold, which are flat. So how does it go about doing this? I'll read a little bit from the summary Prospectus here, which I'll also link to the show notes. So it invests on this index, and the index uses a quantitative methodology to track a diversified portfolio of 12 different commodity futures contracts or components. The position size of each component included in the index is dependent on its historical volatility of that component and the total index value, and is independent of the volatility in the position of the other components in the index. Each index component is then positioned either long or flat. No position, which has the effect of removing exposure to that particular commodity by the index depending on the prevailing price trend of the individual component. When the index rules that a component should have had a flat position, the index will not have exposure to that component. And at times the index may not have exposure to all 12 commodities that comprise the index. The fund will generally reposition the size of each portfolio holding following each month end according to the rebalancing of the index, but may also change the position in the component from a long position to a flat position or no position or vice versa in any given commodity on a daily basis if the index is so adjusted. The index will replace expiring futures contracts based on an optimization process that selects a contract from the universe of all exchange traded futures contracts within the next 13 month period. And I think that's enough of the reading of that summary.

Mostly Voices [4:14]

You are talking about the nonsensical ravings of a lunatic mind.

Mostly Uncle Frank [4:18]

Essentially what it's doing is it is a trend following strategy for commodities in an ETF based on an algorithm. So it's completely automated as far as what it does based on mathematical formulas. All right, question two, is an investment a speculation or a gamble? Well, this is interesting. It is somewhere between an investment and a speculation. It really does not fall specifically within the investment category because it does not generate income. Commodities don't generate income like bonds or stocks. They're not companies. And so it really falls more in the category of a speculation as gold would or any other thing that one might buy on the promise or hope that it would be worth more money later. We would say it's not a gamble because it has a positive expectation. So we would characterize this fund as a speculation. All right, what is the upside? This is question three. Well, the upside is this fund does well when commodities are doing well and it does not do well when commodities are performing poorly. Looking at the returns reported in the summary prospectus, this fund has been around since March 30th, 2017. It has a one-year return of 6.24%. since inception it's got a return of 1.11%, which kind of makes sense that it would have a better return in recent times. Obviously these are not spectacular returns, but most commodity funds did much worse in this period. That actually compares very favorably to other commodities indexes. For instance, in the year of 2020 it was up 5.93% compared with minus 24% for the S&P GSCI index, minus 40% for the BCOM index, and minus 35% for the DBC index, which are all commodities indexes. So its upside is it's going to perform well when commodities are trending and trending higher, which is likely in inflationary or reflationary scenarios. All right, what is the downside? Well, the downside is this kind of fund is not going to perform very well in low interest rate environments, declining interest rate environments like we've had over the past 10 years for the most part until recently. And it's also got a expense fee of 0.7%, which is high for an ordinary stock ETF, but is reasonable for something that is doing what this particular thing is doing with a lot of management of futures contracts involved. So that's question four. Now question five, who is on the other side of the trade? Well, this is just traded out in regular markets. You can buy it through your brokerage just like any other ETF, C.O.M. So it could be anybody on the other side of the trade. In terms of the futures contracts, you are on the other side of the trade. from sellers or people who are thinking that the commodities will decline because this fund is only buying long futures or futures that go up as the commodity goes up in value. Question six, what is the investment vehicle? Well, it's an exchange traded fund, so it's well regulated, it's easy to follow, you can get online and find the particulars of it. as we're linking to in the show notes. It is run by Direxion, which has a lot of different kinds of funds that are specialized in various ways. And so it's one of those specialized funds. Question seven, what does it take to be successful? Well, not a whole lot of effort. You simply buy it and hope it goes up or hope it goes up when you want it to go up, depending on what else you're holding. Like most ETF investing, it's very passive. All right, question seven, who is getting a cut? Obviously the managers of the fund are getting their cut of 0.7%. This fund is also going to generate tax liability. It's not clear how significant that's going to be, but obviously anything that is buying or selling things like futures contracts repeatedly is going to generate taxable events. and that will be accounted for in its distributions. All right, how does this impact your portfolio? Question nine. Well, I ran this through a correlation matrix analysis that I'll link to in the show notes, and I compared it with VTI, the Total Stock Market Fund, VUG, a large cap growth fund, VIIV, a small cap value fund, and then TLT, long-term treasury bonds, GLD, gold, and then I also put in PBDC, which we've used in some of our sample portfolios for a commodities exposure, and also DBMF, which is a managed futures fund that we talked about in episodes 55 and 57. Now this analysis was limited by the time frame for the existence of DBMF, which has only been around since 2019. But when I ran it back to COM's earliest date without the DBMF, it came out with similar results. And if we look at it, we see that the correlations seem to be somewhere between PBDC and DBMF in terms of how correlated it is with these other components. With the stock funds, it's about 0.5 on the correlation, whereas PBDC is up about 0.7% DBMF is down about 0.13%. If we look at its annualized returns compared with PBDC and DBMF, it is higher for this period, 14.61% versus 11.48% for PBDC and 12.02% for DBMF. It has a similar standard deviation or volatility characteristic to DBMF a little less recently, but more if you look at the monthly and annual standard deviations on this chart. And I also went ahead and ran a little back test experiment where I took essentially what looks like our all season sample portfolio, which has PDBC in it as a commodities representative, and modified that a little bit to up that component to 10% of the fund and then compared that portfolio with each of PDBC, COM, and DBMF in it. And the one with the COM in it actually did outperform the other ones just by a little bit and had a higher Sharpe ratio overall. So it seems to be a good fit for a commodities part of a portfolio. And I'll link to that in the show notes as well. All right, question 10, should you invest? Well, if you are looking for exposure to commodities, this would not be a bad thing to use. It does seem to compare favorably with the other ETF options in there. And it also has a bit of that managed futures component in that it's a kind of trend following ETF. which is really kind of where we want to position our commodities exposure to go with the idea of that dragon portfolio. If we go back to episodes 53 and 55, ultimately it would be nice to find a nice ETF that has a trend following strategy for commodities that's viable. And this one seems to at least fit that bill somewhat. So, I would say that if you are looking for a commodities exposure, I would definitely consider this ETF in addition to considering other ones like PBDC or DBMF. But now I see our signal is beginning to fade. Shut it up, you. I did want to keep this one short and focused so we'd have this analysis all in one place. But we will be getting back to the emails with another episode probably this week, even before we get to the weekend. Yeah, baby, yeah! If you have questions or comments for me, please send them to frank@riskparityradio.com that email is frank@riskparityradio.com or you can go to the website www.riskparityradio.com and fill out the contact form and I'll get your message that way. If you haven't had a chance to do it, please go to Apple Podcasts, wherever you get this podcast, leave it a five-star review, subscribe, like it, comment, do all those nice things and I will greatly appreciate it. That would be great. Okay? Thank you for your support. Thank you once again for tuning in. This is Frank Vasquez with Risk Parity Radio signing off. Cool. Fire, fire, fire, fire, fire. The Risk Parity Radio Show is hosted by Frank Vasquez.

Mostly Mary [14:23]

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