June 8, 2010
TIPS strategy considerations
We have used iShares Barclays TIPS Bond Fund (TIP) for some time and prefer it because its duration of 4.93 is shorter than most total market TIPS funds. For a short TIPS strategy, look to PIMCO 1-5 Year U.S. TIPS Index Fund (STPZ). The 2.61 duration is almost half the duration of TIP (source: Morningstar, Inc. as of 4/30/2010). For our actively managed strategies, we use PIMCO Real Return (PRRDX), which uses a variety of techniques to enhance return while controlling interest rate risk.
5. Real Assets: Participate in a recovering global economy
Natural resources and commodities offer good inflation protection and also help diversify your overall portfolio. If you have been hesitant about using them in the past, there are many compelling reasons to use them in a rising rate environment.
Historically, commodities have performed well when rates increase. From 1976 to 2009, the average return for the S&P Goldman Sachs Commodities Index was 18.5 percent in years when interest rates rose. Compare that to the S&P 500 Index average return of 8.8 percent and the Barclays Capital U.S. Aggregate Index of 4.7 percent (source: DWS Investments analysis using Morningstar, Inc. data as of 12/31/2009). The driving factors behind increasing rates are highly correlated to the driving factors behind commodities returns.
Real Assets strategy considerations
ETF advancements over the last five years have expanded access to natural resources and commodities. We added SPDR Gold Trust (GLD) to our tactical models last year as we were wary of inflation and worried about the strength of fiat currency globally. Since GLD holds physical gold, it is taxed differently (as a collectable) than other funds, but we don't feel that should limit its use since there is nothing else like it. To bypass the higher collectible tax rates, use this holding in tax-deferred accounts.
For commodities exposure, we prefer a mutual fund that recently switched its structure to a more quantitative approach. DWS Enhanced Commodity Strategy Fund (SKSRX) takes advantage of the popular Deutsche Bank Liquid Commodities Indices (DBLCI) strategies, but it takes a more diversified approach by using the Dow Jones-UBS Commodity Index as the backdrop. To enhance return, the fund uses mean-reversion, optimal-yield placement (this is important since an inflexible trading policy coupled with a commodity in contango is a drag on returns), and a momentum strategy that has the ability to allocate to cash (up to 50 percent) should the market start to free fall.
The Time for Action Is Now
While we watch with anticipation to see when the Fed will drop its "extended period" language, the strategies above can prepare your clients’ portfolios for rising rates and the economic factors that will precipitate the increase. As with most successful strategies, you have to take action early to realize the true benefits.
Kane Cotton, CFA, is chief investment strategist of the Capital Allocation & Management program at Bellatore Financial, Inc. Jonathan Scheid, CFA, is president and chief investment officer of Bellatore Financial, Inc., an innovative turnkey asset management provider in San Jose, CA. More information about Bellatore can be found at www.bellatore.com.
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