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PIMCO Commodity Real Return Fund – Not the Inflation Protector it Claims to Be

PIMCO Commodity Real Return FundSince 2002, PIMCO has offered the PIMCO Commodity Real Return Fund (PCRAX).  The fund’s fact sheet (published on June 30th, 2012), describes it as “Capturing The Diversification and Inflation-Hedging Potential of Commodities”.

The marketing for the fund also includes the following statement:

Why invest in this fund?  A Double Real™ inflation-hedging strategy

For investors who are concerned about inflation, this may sound like a great choice from one of the largest asset managers in the world.  Upon a closer look however, the fund would actually be a terrible choice for an investor looking to protect themselves from inflation.

 

Why the PIMCO Commodity Real Return Fund is a Bad Choice for Inflation Protection

The fund has a two pronged approach to fighting inflation:

  1. Buy commodities
  2. Hold the collateral in TIPS (Treasury Inflation Protected Securities).

The PIMCO Commodity Real Return Fund’s performance has been tremendous over the last decade, averaging almost 10% per year on average. However, these returns don’t really match up with inflation (as measured by the Consumer Price Index CPI).  They also don’t match up with the commodity index which the fund benchmarks its performance against. Even if you combined CPI with the commodity index, the results would not come close to tracking the fund’s performance.

20082009201020112012 (thru July)
PIMCO Commodity Real Return Fund-43%40%24%-8%7%
CPI0.1%2.7%1.5%3.0%1.8%
Dow Jones – UBS Commodity Index-36%19%17%-13%3%
CPI + Dow Jones UBS Commodity Index-36%22%19%-10%5%

 

What do the Above numbers show?

  • The PIMCO Commodity Real Return Fund’s performance is very volatile. Since 2007, its annual returns have ranged between -43% and +40%. The range of returns for the commodity index has been between -36% and +19%.
  • Inflation seems to have very little with the performance of the fund. During this period, inflation has ranged between 0.1% and 3.0%. Ironically, the fund had its worst performance during 2008 and 2011, the lowest and highest years of inflation.

Why does the performance of the fund have little to do with inflation?

The answer is simple: Commodity prices don’t move in line with inflation

When most people talk about inflation (the increase in the prices of goods and services over time) they are referencing the Consumer Price Index (CPI-U). CPI tries to approximate the cost of living for a “normal” person living in an urban environment.

CPI and commodity prices are not strongly linked. There have been several studies which show a strong link between the costs of raw materials and inflation was tight in 60s and 70s.  Since then however,  the relationship has been very indirect.

On an intuitive level, the cost of the raw materials that go into making a product or delivering a service should have a major impact on the final price. However, over the last several decades, the percentage of a product’s costs that can be attributable to raw materials and energy inputs has declined dramatically. Labor costs, marketing and sales costs, and technology costs have become much more important than energy and raw materials.

 

Shouldn’t the funds TIPS holdings move with inflation?

Yes, Treasury Inflation Protected Securities change in value with inflation expectations.  However, there are a few factors to consider:

  1. Commodity prices have had dramatic moves over the last 5 years. Changes in inflation have been very moderate compared to movement in commodities.
  2. While TIPS change in value due to inflation, they also change in relation to overall interest rates. PIMCO’s decisions in regards to maturities of the TIPS they buy for the fund, may be having more impact than inflation.

Why are we being critical of Bill Gross? Hasn’t the fund done well?

The portfolio manager of the fund is not Bill Gross. That honor belongs to Mirih Worah. However, Bill Gross is PIMCO’s Co Chief Investment Officer and its front face. I want to hold him accountable for the following statement made in the funds marketing:

Why invest in this fund? A Double Real™ inflation-hedging strategy

This fund does not offer inflation protection, and in fact would be a terrible choice for an investor looking to protect themselves from inflation.

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