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The Year of the Dog

Zadie in her natural habitat.

2018 is the year of the dog. It’s #11 of the 12 Chinese zodiacs. It seems to us that every year is really the year of the dog. No other animal, or person for that matter, gets nearly as much affection as the dog. We have a dog at GreenPort. It’s actually Sophie’s dog and her name is Zadie (named after the author Zadie Smith). Zadie likes to greet clients with a wagging tail and is usually rewarded with a quick scratch behind the ears and a compliment about her cuteness. She then retreats to her bed cushion under the conference table and gets back to her nap.

Last week Zadie napped under the table while we reviewed our Moderate Portfolio with a client. The Moderate Portfolio has a long-term allocation of 60% stocks and 40% bonds. Our client asked a great question, “Why don’t you include commodities in the strategic allocations of the Core Portfolios?”

The answer is commodities as an asset class have very poor long-term risk and return characteristics. They can be useful as a tactical allocation, but over the long term, returns are sub-par. Commodities can be broken down into 3 main subgroups: metals, energy, and agriculture. While agriculture has a slightly better risk premium than metals or energy, no subgroup is attractive as a long-term investment. A common misconception among investors is that the change in the spot price of a commodity is synonymous with the investor’s return. It’s almost a universal truth that the investor receives far less than the change in spot price would suggest. This is because of “negative carry cost”. Commodities, unlike stocks, are physical things. If an investor wants to buy a barrel of oil, there will be a literal barrel involved in the process. To buy actual physical oil the investor would need to have the barrel shipped to his house, store the barrel, and then pay to have the barrel reshipped when he decides to sell the oil. There would be a large cost involved with that.

So what investors do is buy a “future” on the commodity. For example, if you wanted to invest $10,000 in oil, you don’t buy physical barrels of oil (spot price), rather you buy a futures contract on the price of oil. A futures contract allows the investor to avoid the unrealistic logistic hassle. However, the future contract factors in the cost of someone else bearing these costs. Therefore, the net gain to an investor is usually far less than a spot price would suggest. Below is a chart showing the return an investor would have received on a $10,000 investment in U.S. Stocks (Vanguard Total Market Return Index), 10 Year US Treasury Bonds, and Commodities (Goldman Sachs Commodity Index) over the last 10 years. Longer term returns aren’t as dramatic, but the story is similar. As a result, at Greenport we don’t include commodities in our strategic allocation of the Core Portfolios. In rare circumstances, such as a high inflationary environment, we may invest tactically to take advantage of a short-term surge in commodity prices.

GreenPort’s Core Portfolios are designed to optimize our client’s return relative to their risk appetite. There are three critical components to achieving this:

  • researching and understanding the long-term volatility and return profile of each available asset class

  • combining each asset class at the proper percentages to take full advantage of diversification

  • adjusting these allocations depending upon market risks and opportunities

Conservative Core Portfolio

Moderate Core Portfolio

Aggressive Core Portfolio

We believe our thorough understanding and explicit communication about the characteristics of the Core Portfolios provides our clients with the best opportunity to achieve their investment goals. Our belief is that successful investing involves both investment knowledge and an understanding of investor emotions. By providing investors a clear expectation of returns and volatility and then monitoring and reviewing the portfolio with the investor, together we can achieve our financial goals.

The GreenPort Team

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