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Issue21 - Commodity Fund Fundamentals


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Commodity Fund Fundamentals

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Issue21 - Commodity Fund Fundamentals

  1. 1. Ross Naylor +48 (22) 389 65 70 (w) +48 512 275 706 (m) ul. Królewska 27 lok 411 Warszawa 00-060 PolandCommodity FundFundament als 2010 was a bumper year for commodities. Cotton was up by 96%, coffee by 62% Did You Know? and copper by 30%. The average annual cost of a In fact I am room in a nursing home in the struggling to think UK is GBP36,000. of a commodity thatdidn t have a stellar year. If you have assets in excess of GBP23,000 (including yourHowever, the same cannot be said for all commodity house) then you will have tofunds. Why is this? pay that all by yourself.The main reason is that not all commodity funds invest inthe same way. The generic label "commodity fund"actually captures several distinct types of investment. It istherefore important that you understand how your chosencommodity fund works before taking the plunge.To help you do so, I have listed the 3 main types ofcommodity fund below.
  2. 2. True Commodity Funds These funds actually have adirect holding in the relevant commodities. A commonexample is a gold fund. The main reasons that gold ismore common as a direct holding are:a) It doesn t deteriorate over timeb) You require a lot less space to store gol d which costsUSD1,400 an ounce t han you do oil at USD100 a barrel.Commodity F unds that Hold Futures Contracts Amuch more common strategy is for the fund to holdderivative contracts based on the underlying commodityprice. The reason for this is that most investors have nodesire to take delivery of hogs, corn, oil or any other One To Watchcommodity, they simply want to profit from price changes. I first came across the name Terry Smith years ago. HeThis type of fund however exposes you to the risk of was the author of a book contango . Normally the price to buy a commodity today called "Accounting for(spot price) is higher than the price to buy it in the future. Growth".However, in times of high demand or uncertainty thefuture price can be higher than today s spot price. When The book caused a bit of athis happens there is a risk that when the futures contract stink at the time as it exposedmatures, it will do so at a price lower than the original the shoddy accountingpurchase price, thus creating a loss. practices of a number of w ell known companies. It also costA good example of this was back in 2008 when funds him his job. Not surprisingholding oil futures contracts managed to lose money really, as the companies indespite the price of oil surging to USD150 a barrel. question were clients of the bank that he worked at the time.Natural Resource Funds These are f unds that investin shares of companies that are engaged in commodity Anyway, I recently camerelated fields, such as energy, mining, oil drilling and across his name again whenagricultural businesses. my father sent me details of a new fund that he had launchedWhile they hold neither actual commodities nor (Thanks Dad).commodity futures, they still provide some exposure tothe underlying commodities markets by proxy. The fund is called The Fundsmith Equity Fund and heThe downside to natural resource funds as opposed to promises that it will be a bitthe other 2 is that, while actual commodities and different. Some of the keycommodity futures historically have a low correlation to features are:the equity markets that probably make up the bulk of your
  3. 3. current portfolio, natural resource funds will be morecorrelated as at the end of the day they are still investing * A focus on a concentratedin stocks. portfolio of only 20-30 stocks. * To invest in high quality businesses which have advantages that are hard to replicate. * To invest in businesses that are resilient to change.As always... * No entry/exit fees.thanks for reading. Your time is greatly appreciated. Best of all, he is puttingIf you have any specific queries related to financial GBP25 million of his ownplanning and are looking for a simple, common sense money into the fund, thusanswer, feel free to drop me a line and I will do my best showing that a) he is puttingto provide it. his money where his mouth is and b) to have generated t hat kind of money in the first place, one would guess thatDisclaimer he has at least half an idea what he is doing.The views expressed here are my own. They are notnecessarily shared by AES International. They are The main drawback is that thesubject to change at any time based on market and other fund has only been running forconditions. a few months, so has no real track record.This is not an offer or solicitation for the purchase or saleof any security and should not be construed as such. Aside of that, I like his styleReferences to specific securities are for illustrative or and his common senseinformational purposes only and are not intended to be, approach. Definitely one toand should not be interpreted as, recommendations to watch.purchase or sell such securities.My day job is as a qualified financial planner. Thisentails me giving my clients advice on maximizing thereturns on their investments within their specified riskparameters. This may or may not involve merecommending some of the securities listed above. Sign Up
  4. 4. If you have been forwarded this ezine by someone else and wish to sign up to receive future issues automatically, just enter your e-mail address here.Call me: +48 (22) 389 65 70 (w) +48 512 275 706 (m)