In times of great market turmoil, it's not uncommon for investors and professional money managers alike to reevaluate their approaches to investing. After what's happened to the market and the economy in recent years, a lot of people are making tweaks and adjustments to their portfolios to make up some of that lost ground and better position themselves for what's next. Unfortunately, many of these same individuals may end up making moves at exactly the wrong time, which could end up costing them.
Following the money
It's no secret that retail investors and no small number of professionals are prone to performance-chasing behavior. History has shown that once particular asset classes or segments of the market begin to outperform, the money follows the returns, fast and furious.
The latest group getting in on the act appears to be target-date funds, many of which are now beefing up on their exposure to commodities. While many managers are undoubtedly adding these commodity positions to help reduce volatility in the portfolio, I'm equally sure that many are simply chasing performance, especially since many individual commodities, notably gold, have done extremely well in recent years.
Target-date funds are marketed as one-stop shops for investors who lack either the knowledge or the desire to build a portfolio of individual mutual funds or stocks. These funds typically invest in a range of other mutual funds from the same fund family, and attempt to build a diversified portfolio. Over time, the fund manager adjusts the allocation within the fund, stepping down equity exposure and increasing fixed income as the investor gets closer to retirement.
Target-date funds have become increasingly important in the investment world, since many retirement plans use them as default options to automatically enroll plan participants. That means more and more people are likely to use target-date funds as their primary tool for saving for retirement.
Hurry up to catch up
If you own a target-date fund, make sure you know whether your fund is moving into commodities. You should be able to get details on the underlying holdings in your fund, so check to see whether your fund owns any commodity or "real return" funds. A small allocation probably won't be too dangerous, but if you've noticed a marked increase in recent quarters, you might want to consider switching to another fund. A hefty commodity allocation likely means that the manager is looking to play catch-up with returns, rather than simply aiming to diversify the portfolio.
Fund families that have not added commodity exposure to their target-date funds include American Century and Vanguard. If you've got some flexibility in your retirement plan, consider checking out their lineups of target-date funds. But even if you don't have a lot of fund options in your employer-sponsored retirement plan, or you don't want to move out of your current target-date fund, it will help to simply be aware of how much commodity exposure your fund has. That way, you'll have fewer surprises down the road if this asset class zigs or zags any certain way.
A balanced view
In general, I'm still not convinced that commodities are an essential part of any investor's portfolio. Historically, most commodities have simply not produced enviable long-term returns. Of course, most folks like to tout commodities' diversification benefits. And while that may have been true in the past, recent data have shown that commodities are becoming more and more highly correlated with equities. A study by RS Investments earlier in 2010 noted that in more recent years, diversification results for commodities have been mixed. Apparently, commodities' correlations with inflation have remained strong, but their correlation to stocks has been on the rise, reducing their potential diversifying powers.
However, if you still want to take a chance on commodities, the best thing you can do for your portfolio is to keep your overall allocation low, ideally no more than 5%. If you're looking for broad exposure to commodities, your best bet is a low-cost exchange-traded fund like the PowerShares DB Commodity Tracking Index
Of course, even if you don't want to buy commodity ETFs, you can still harness some of the power of this corner of the market by purchasing commodity-related stocks. For example, buying Freeport-McMoRan Copper & Gold
So even if commodities do well as an inflation hedge in the coming years, they should be used sparingly and cautiously. If you're a target-date fund investor, or even an investor in a fund that gives your manager wide latitude, make sure you have an idea of how much exposure you have to this corner of the market.