How to Make Money from Inflation (WSJ)

WEEKEND INVESTOR
FEBRUARY 5, 2011.How to Profit From Inflation
The Scourge of Rising Prices Hasn't Hit Home Yet, but the Underlying Signs Point to Trouble Ahead. Here's What You Should Do Now.

By BEN LEVISOHN and JANE J. KIM

Inflation,long a sleeping giant, is finally awakening. And that could present problems—along with opportunities—for investors.

A quick glance at the overall inflation numbers might suggest there is little reason to worry. The most recent U.S. Consumer Price Index was up just 1.5% over the past year. Not only was that lower than the historical average of about 3%, but it was uncomfortably low for Federal Reserve Chairman Ben Bernanke, who prefers to see inflation at about 2%.

What to Do Now
Sell
Cash and Bonds: Treasurys, long-term bonds
Stocks: Financials, utilities and consumer staples
Hard Assets: Gold, real estate

Buy
Cash and Bonds: Floating-rate funds, inflation-linked CDs
Stocks: Small-company value stocks
Hard Assets: Commodities, real-return funds

Yet it is a much different situation overseas, particularly in the developing world. In South Korea, the CPI rose at a 4.1% clip in January from a year earlier, higher than the 3.8% estimate. In Brazil, analysts expect prices to rise 5.6% this year, exceeding the central-bank target of 4.5%. China, meanwhile, has been boosting interest rates and raising bank capital requirements to keep inflation, which rose to 4.6% in December, in check.

"Emerging market economies are overheating," says Julia Coronado, chief economist for North America at BNP Paribas in New York. "They need to slow growth or inflation will become destabilizing."

Even some developed economies are seeing rising prices. Inflation in the U.K. surged to 3.7% in December, while the euro zone's rate climbed to 2.4% in January, the fastest rise since 2008.

Much of the uptick has been driven by commodity prices. During the past six months, oil has jumped 9%, copper has gained 36% and silver has shot up 56%. Agricultural products have soared as well: Cotton, wheat and soybeans have risen 100%, 24% and 42%, respectively. That's a problem because rising input prices "work their way down the food chain to CPI," says Alan Ruskin, global head of G-10 foreign-exchange strategy at Deutsche Bank.

Of course, the main inflation driver is usually wages—and that isn't a factor in the U.S., where high unemployment has kept a lid on pay for three years.

Yet there isn't a historical blueprint for the inflation scenario that seems to be unfolding now. Not only has the global economy changed drastically since the last big inflationary run during the 1970s, but the lingering effects of the recent debt crisis remain a wild card.

For investors, that means traditional inflation busters such as real estate and gold might not work as expected, while other strategies might perform better.

So how should you position your portfolio? The best approach, say advisers, is to tweak asset allocations rather than overhaul them. That involves dialing back on some kinds of bonds, stocks and commodities and increasing holdings of others. Here's a guide:

What to Sell
• Bonds. The price of a bond moves in the opposite direction of its yield. When inflation kicks up, interest rates usually move higher, pressuring bond prices. Even buy-and-hold investors get hurt, because higher inflation erodes the real value of the interest payments you receive and the principal you get back when the bond matures.

'There is no historical blueprint for the inflation scenario that seems to be unfolding now.'.The drop is usually most extreme in longer-dated bonds, because low yields are locked in for a longer period of time. So inflation-wary investors should shorten the maturities of their bonds, say advisers.

The safest bonds, especially Treasurys, are usually hardest hit, because those are the most influenced by changes in rates—unlike corporate bonds, whose prices also move based on credit quality. From September 1986 through September 1987, for example, as inflation moved higher, Treasurys dropped 1.2%.

It might even make sense to dial back on Treasury inflation-protected securities, whose principal and interest payments grow alongside the CPI. That's because investors already have flooded into TIPS, driving up prices and driving down the real, inflation-adjusted yields. A typical 10-year TIPS, for example, yields just 1.1% after inflation, compared with an average of more than 2% in recent years.

With so little cushion, long-term TIPS carry a higher risk of loss for investors who are forced to sell before the bonds mature. "Even if inflation is rising, you can still lose money," says Joseph Shatz, interest-rate strategist at Bank of America Merrill Lynch.

• Hard assets. Real estate may be a classic inflation hedge, but it seems likely to disappoint investors this time around. Even though rising inflation should put upward pressure on home prices, the twin forces of record-high foreclosures and consumers reducing their debt loads are expected to mute price gains for several years, says Milton Ezrati, senior economist at asset manager Lord Abbett. That's a far cry from the 1970s, when the median home price rose 43%, according to U.S. Census data.

Gold is another traditional inflation hedge that might be less effective now. With prices already having more than quadrupled over the past nine years, many strategists see substantial inflation already factored into the price.

Hot Commodities
Commodities that are more closely tied to industrial or food production seem better positioned now than gold, say advisers.

Historically, gold has moved with the money supply. During the last 30 years, the correlation has been about 69%, according to FactSet data. (A correlation of 100% means two indexes move in lockstep all the time; a correlation of minus-100% means they move in perfect opposition.) Based on the money supply alone, gold is priced 25% above where it should be, says Russ Koesterich, chief investment strategist at BlackRock Inc.'s iShares.

• Stocks. Equities can be a decent hedge against creeping inflation, because companies are better able to pass off costs to customers. But when input costs suddenly jump, profit margins take a hit.

At the same time, the higher interest rates that accompany inflation prompt investors to demand more profits for each dollar invested. As a result, price/earnings ratios tend to shrivel. Over the past 55 years, the average trailing P/E ratio of a stock in the Standard & Poor's 500-stock index has fallen to 16.95 during periods with inflation running between 3% and 5%, from 19.24 during periods with inflation of 1% to 3%, the most common inflation range since 1955, Mr. Koesterich says.

Sectors that are sensitive to interest rates, including financials, utility stocks and consumer staples, are especially vulnerable, say advisers.

What to Buy
• Cash and bank products. Money-market mutual funds are more attractive in inflationary environments because the funds invest in short-term securities that mature every 30 to 40 days, and therefore can pass through higher rates quickly. In an extreme example, money funds posted yields over 15% during the inflation-ravaged 1970s and early 1980s, says Pete Crane of Crane Data, which tracks the funds.

A growing number of inflation-linked savings products are cropping up as well. Incapital LLC, a Chicago investment bank, says it has seen a pickup recently in issuances of certificates of deposit designed for a rising-rate environment. Savers, for example, can invest in a 12-year CD whose rate starts at 3% then gradually steps up to 4.25% starting in 2015, and peaks at 5.5% starting at 2019 until the CD's maturity in 2023.

A caveat: If inflation eases and rates fall, investors could get burned, since the issuer may call the CDs and investors would lose out on the higher rates at maturity.

• Bonds. One way to reduce the impact of rising inflation on bond holdings is to build a bond ladder—buying bonds that mature in, say, two, four, six, eight and 10 years. As the shorter-term bonds mature, investors can reinvest the proceeds into longer-term bonds at higher rates.

"A bond ladder is best for someone who doesn't mind holding them for up to 10 years," says Jeff Feldman, an adviser in Rochester, N.Y.

Highly cautious investors might prefer the I Bond, a U.S. savings bond that earns interest based on a twice-yearly CPI adjustment. Although the current yield on I Bonds is only 0.74%, that yield is likely to move higher on May 1, the next time the rate is adjusted. I Bonds aren't as volatile as TIPS and appeal to conservative, buy-and-hold investors. The interest may also be tax-free for some families for education expenses.

More adventurous types might consider the inflation-protected government debt of other nations, which carry higher yields along with greater risks. The SPDR DB International Government Inflation-Protected Bond Fund is an international inflation-protected bond exchange-traded fund designed to do well if inflation in overseas countries moves higher. The fund returned about 6.8% in 2010 and 18.5% in 2009, according to Morningstar Inc.

• Bank-loan funds. Another way to exploit rising inflation is through mutual funds that buy adjustable-rate bank loans, many of which are used to finance leveraged corporate buyouts. So-called floating-rate funds are structured so that if interest rates rise, they collect more money. During periods of rising rates, floating-rate funds usually outperform other bond-fund categories. In 2003, for example, as investors anticipated higher interest rates and a stronger economy, bank-loan funds gained 10.4% while short-term bond funds gained 2.5%.

Now, amid expectations of rising inflation, investors are once again flocking to these funds, pouring in about $7.6 billion into loan funds in the fourth quarter of last year, according to Lipper Inc.—more than double the previous quarterly record set in 2007. The pace has accelerated this year, with investors putting in about $3.4 billion thus far.

After gaining almost 10% last year, the funds shouldn't be counted on for much price appreciation, says Craig Russ, who co-manages $22.7 billion of floating-rate investments across three floating-rate funds and other accounts at Eaton Vance Corp., including the Eaton Vance Floating Rate Fund. But the funds generate plenty of income, yielding about 4% to 5% now, according to Morningstar.

Price Increases
From Aug. 2, 2010 through Feb. 4, 2011:

Cotton: +100%
Silver: +50%
Soybeans: + 42%
Copper: +36%
Wheat: +24%
.


Be warned: Floating-rate funds can get creamed when investors fear the underlying loans are too risky. In 2008, for example, bank-loan funds lost 29.7%, although they zoomed 41.8% in 2009, according to Morningstar. What's more, banks are beginning to make riskier "covenant-light" loans that carry fewer stipulations for corporate borrowers—a sign of frothier trends in the market.

Given the potential for volatility, floating-rate funds are best viewed as a complement to—not a replacement for—investors' core bond holdings. Among Morningstar's picks in this category is the Fidelity Floating Rate High-Income Fund, among the more conservative in the category.

• Commodities. Materials that are more closely tied to industrial or food production seem better positioned now than gold, say advisers. The trick is to find the best investment vehicle.

The easiest way for small investors to gain exposure to most commodities is through exchange-traded funds, many of which use futures contracts. But such funds can be dangerous because they often face "contango"—when the price for a future delivery is higher than the current price. The result: The ETFs lose money as they buy new contracts, even when prices are rising.

The losses can be extreme. In 2009, for instance, while the price of natural gas rose 3.4%, the United States Natural Gas Fund lost 56.5% as a result of rolling over futures contracts.

Some firms have rolled out ETFs that aim to address the problem. One of Morningstar's picks is the U.S. Commodity Index Fund, run by U.S. Commodity Funds LLC. The portfolio buys the seven commodities that are most "backwardated"—the opposite of "contango," so rolling contracts should result in a profit—along with the seven commodities with the most price momentum.

"USCI provides an outlet for investors who want broad commodities exposure but don't want to worry about the daily dynamics," says Tim Strauts, a Morningstar analyst.

Other funds play inflation by holding many different assets to protect against rising prices no matter where they show up. The IQ Real Return ETF, launched in 2009 by IndexIQ, aims to provide a return equal to the CPI plus 2% to 3% over a two- to three-year period. To get there, it invests across a dozen or so inflation-sensitive assets—including currencies and commodities.

• Stocks. One corner of the market tends to do better when prices rise suddenly: small-company value stocks. "Because value and small stocks tend to be fairly highly [indebted] companies, inflation reduces their liabilities," says William Bernstein of Efficient Frontier Advisors LLC, an investment-advisory firm in Eastford, Conn.

From January 1965 through December 1980, for example, inflation averaged 6.6% a year. The Ibbotson Small-Cap Value Index posted average annual returns of 14.4%, according to Morningstar's Ibbotson Associates, double the S&P 500's 7.1% gain.

Morningstar's picks in the small-cap value fund category include Allianz NFJ Small Cap Value, Diamond Hill Small Cap, Perkins Small Cap Value and Schneider Small Cap Value. Just be warned: Small value stocks have had a good run recently, returning 134%, on average, since March 6, 2009.

In the end, the particulars of any inflation-fighting plan may not be as important as developing a plan in the first place.

"The real problem you run into with any kind of inflation hedges," says Jay Hutchins, a financial adviser in Lebanon, N.H., "is that if you don't already have them when inflation is around the corner, you've missed the boat."

Write to Ben Levisohn at ben.levisohn@wsj.com and Jane J. Kim at jane.kim@wsj.com

Copyright 2011 Dow Jones & Company, Inc. All Rights Reserved

Gold ETF IAU 10 for 1 stock split (ishares)

BlackRock Announces Share Split of iShares® COMEX® Gold Trust
San Francisco, CA, June 11, 2010—BlackRock, Inc. (NYSE: BLK) today announced that the Board of Directors of BlackRock Asset Management International Inc., sponsor of the iShares® COMEX® Gold Trust (NYSEArca: IAU/TSX: IGT) (the "Trust") has authorized a 10 for 1 split for shareholders of record as of the close of business on June 21, 2010, payable after the close of trading on June 23, 2010. The Trust shares will begin trading with split-adjusted pricing on the NYSEArca on June 24, 2010. The Trust, which is cross-listed on the Toronto Stock Exchange, will commence trading on a split adjusted basis on TSX on June 17, 2010. Post-split shares are expected to be distributed to shareholders' accounts on June 28 2010, and shareholders are expected to see the change in their holdings sometime after June 28, depending upon their brokerage firm's procedures.




The 10-for-1 split will lower the share price and increase the number of outstanding shares. The total value of shares outstanding is not affected by a split.



Hypothetical example of 10-for-1 split:



Period Number of Shares Owned Hypothetical Market Price/Share (U.S.$) Total Value (U.S.$)
Pre-split 100 $120 $12,000
Post split 1,000 $12 $12,000

Shares of the iShares® COMEX® Gold Trust are expected to reflect, at any given time, the price of the gold owned by the Trust, less the Trust's expenses and liabilities. As of June 10, 2010, the Trust had U.S. $3.3 billion in total net assets.

Making Money from Volatility (WSJ)

Playing The Market Plunge
The Return of Volatility Has Investors on Edge. Here's What to Do Next
By JEFF D. OPDYKE, JANE J. KIM, ELEANOR LAISE and LAURA SAUNDERS

Lest anyone had thought the rally of the past 14 months had restored calm to the stock market, Thursday's trading action was a reminder that the investing game is as dicey as ever.

During one brief afternoon spasm in which the Dow Jones Industrial Average plunged nearly 1,000 points, happy assumptions about the markets' solid footing and the U.S. economy's enduring recovery were wiped away. More selling on Friday reinforced the growing sense of unease.


"People had been thinking, 'Oh, that [global financial crisis] thing; I'm glad that's over,' and we're back to the races again," says Rob Arnott, chairman of Research Affiliates, a Newport Beach, Calif., investment firm. "But when expectations are that everything is fine again, a bolt from the blue can come from anywhere to send this market lower very quickly. It's a wake-up call that risk remains in the system."

Most unsettling was the apparent lack of an explanation for Thursday's violent swing. With the Greek debt crisis as a backdrop, some pointed to glitches in computer-trading programs. But upsets in a mechanism as complex as the global financial markets have no simple causes. Regulators and economists are poring over the trading tape in search of an answer.

It wasn't only individual stocks that were whipsawed. Several exchange-traded funds—portfolios that are listed on stock exchanges—traded at zero for a spell on Thursday. One, Vanguard Industrials, a basket of 372 stocks, fell from $54.66 to zero at 2:46 pm, then shot back up around $40 by 2:48 pm, then crashed right back down to 20 cents at 2:54 pm, then leaped back up by $54 by 3:06 pm.

The good news was that many of the trades that took place during those perilous few minutes are being canceled. The bad news is that the Dow still lost 5.7% for the week, its worst performance since March 2009.

Greece has investors the world over fretting that an economic contagion will sweep through Europe, which could, in turn, undermine major U.S. companies that sell into the European market. And although the U.S. economy is looking a bit healthier these days, fund managers say analysts' earnings estimates for U.S. companies are inflated by unrealistic profit-margin expectations; if earnings later this year start to arrive lighter than expected, the stock market could again see a sell off.


This week's instability and the possibility of more troubles have prompted investors like Maureen Green to rethink their portfolios. The 62-year-old retired nurse in Sarasota, Fla., estimates she lost about $40,000 on Thursday and is now planning to sell a chunk of her stocks. She says that until this week she had considered herself an aggressive investor, with 65% to 75% of her investments in stocks. Now, she's planning to bring that equity allocation closer to 55%.

"After having gone through the last two years," Ms. Green says, "there was such a lump in my stomach. It's too scary, especially when you're retired and this is what you're living on."

At times like these it is important to remember that the soundest investment strategies are built on level-headed stability and long-term execution. Not only can periods of high volatility be tamed—they can even create opportunities for profits.

Investors concerned with safety needn't flee stocks entirely to tone down their portfolio's risk. Lou Stanasolovich, president and chief executive of Legend Financial Advisors in Pittsburgh, offers clients several low-volatility portfolios that combine bond holdings with stock-focused funds that can also trade options or sell stocks short. Shorting involves selling borrowed shares in the hopes of buying them back later at a lower price.

Legend's most conservative portfolio, designed to have less volatility than an intermediate bond fund, has a 75% bond allocation. But it also includes mutual funds like Hussman Strategic Growth, which can use options and index futures to reduce exposure to market swings, and Caldwell & Orkin Market Opportunity, which uses short-selling and other strategies to neutralize the negative impacts of falling stock prices.

Investors who simply want to insure against a big market tumble can buy "put" options that rise in value as a broad-market index like the S&P 500 declines because they allow the owner to sell the index at a higher level.

Another options strategy that can help tamp down volatility: covered-call writing, which involves selling call options on stocks you already hold. (Selling a call obligates you to sell the shares at a predetermined price on or before a predetermined date.) The "premium" you receive—the price of the option that the buyer pays to you—tends to rise along with market volatility, and that income can provide some buffer against modest stock declines. In market rallies, however, this strategy lags because, amid soaring prices, stocks get called away by the buyer of the call options.

People who don't want to dabble directly in options trading can pursue this strategy through a fund such as the PowerShares S&P 500 BuyWrite ETF.
Investors seeking insulation from the market's ups and downs might also consider a counterintuitive step: buying direct exposure to market volatility. The iPath S&P 500 VIX Short-Term Futures exchange-traded note, for example, seeks to mimic the Chicago Board Options Exchange Volatility Index, or VIX.

Since volatility spikes tend to coincide with stock-market crashes, such an investment should zig when stock holdings zag and provide "a way to smooth out the entire portfolio," says Paul Justice, associate director of ETF research at investment-research firm Morningstar Inc.
Matthew Tuttle, a financial adviser in White Plains, N.Y., actually made money on one of his portfolios during Thursday's wild ride. He had a 15% position in the iPath exchange-traded note. That position, which gained 12% on Thursday, helped Tuttle's portfolio—which also holds gold and is short Treasurys—eke out a 1% gain for the day.

"Initially, when we put the trade on, it was a protection strategy," says Mr. Tuttle, who added the VXX in March. But he says he's also been able to profit from the position, which is up 31% since he bought it.

People can also invest in "bear market" funds, which aim to move in the opposite direction from specific market indexes. Though these funds do well in down markets, "their long-term returns haven't been very good,' says Russel Kinnel, director of fund research at Morningstar. ProFunds' UltraBear ProFund, for example, posted total returns of 65% in 2008, lost 52% last year and is down about 7% so far this year.
Meanwhile, so-called long-short, market neutral and absolute-return mutual funds, which follow hedge-fund strategies in hopes of generating returns in any market environment, can help pare losses in a down market, but often lag during a bull run.

A market plunge is also a good opportunity for investors to evaluate their diversification strategies. Diversification isn't only about owning a broad mix of drug stocks, retailers and energy companies. The practice takes many forms—across asset types, time and credit profiles, among others.

Over the last decade, even a strategy as simple as holding 60% stocks and 40% bonds beat the Standard & Poor's 500-stock index by more than six percentage points, and with far less risk. Over long periods, owning exposure to multiple types of assets, from stocks, bonds and cash to alternative assets like real estate, gold and commodities, can smooth the ride and boost returns.

In shorter time periods, diversification is less of a cure-all. An extreme downdraft can pull many asset classes down at once. During the financial crisis, notes financial planner Dean Barber in Lenexa, Kan., 38 of 41 asset classes declined at once—everything but cash, gold, and short-term Treasurys. So investors should be mindful of their time horizon: the sooner they need their money, the more of it should be in cash.
The strategy known as dollar-cost averaging is an easy way to diversify away the risk of time: by buying stocks in regular intervals rather than all at once, investors can lower the risk that they're jumping in at a short-term market top.

Grant Gardner, research director at Russell Investments, recommends investors also diversify across credit risks. How sound, for instance, is the insurance company that sells an annuity, or the municipality backing your local-government bonds? Concentrating too many of your assets in a single financial-services company can expose a portfolio to the risk that a major upheaval disrupts that firm's operations.

Finally, investors should marshal their cash smartly. For a decade or more, Wall Street's financial-planning machinery has claimed to have optimized the investing equation and boiled it down to simple calculations encouraging investors to abide by asset-allocation models heavy reliant on stocks, bonds and alternative assets. Cash was generally limited to a small fraction of an overall portfolio.

Yet cash serves a useful purpose, even if it earns paltry yields. It's emotional ballast.
In moments of unexpected market convulsions, low-cash portfolios are more painful both financially and psychologically. During Thursday's meltdown, for example, Christopher Schons, an aviation-policy analyst in Arlington, Va., watched nearly 10% of his family's wealth vanish on paper in just minutes. "I felt like I was in a Dali painting," he says.

Mutual-fund firm Invesco takes a "barbell" approach in its Charter Fund that is easily applicable to individual investor portfolios: 80% to 85% of its assets in investments on one side and 15% to 20% in cash on the other.

"Cash doesn't have market risk," says Ron Sloan, chief investment officer of Invesco's U.S. core equities group. "Don't be afraid to leave money on the table for your own sleeping comfort."

—Jason Zweig contributed to this article.
Write to Jeff D. Opdyke at jeff.opdyke@wsj.com, Jane J. Kim at jane.kim@wsj.com, Eleanor Laise at eleanor.laise@wsj.com and Laura Saunders at laura.saunders@wsj.com

Printed in The Wall Street Journal, page B7

Stocks that Benefit from a Weak Dollar (Investopedia)

Stocks That Benefit From A Weak Dollar
Posted: Oct 12, 2009 09:23 AM by Sham Gad

There's a lot of talk today about the future of the dollar. If left unchecked or without an appropriate exit strategy, our massive stimulus programs will have a crippling effect on the value of the dollar. It's simple economics: if you increase supply without a similar increase in demand, the price of your product drops.


What to Consider
Exporters benefit when their home currency weakens relative to the rest of the world because their trading partners can now buy their product for less. This is why China's currency has been undervalued for years. The Chinese government does not let the yuan float freely, which leads many to cite that as the reason China's exports are so incredibly cheap.

Oil and gold also benefit from a weak dollar. Gold is often perceived as a safe haven during periods of asset devaluation. Oil benefits because it's priced in dollars. As we've seen with the oil price over the past few months, that indeed seems to be the case.

Quality Always Matters
So commodity businesses that have pricing power and U.S. companies that do brisk business abroad benefit from a weaker dollar. But let me go on record as saying over the long run, it's not beneficial for a country to continually suffer from a weak currency. In the case of the U.S., that rings even more true since the greenback is regarded as the world's premier currency.

Nonetheless, major oil companies like ConocoPhillips (NYSE:COP) and ExxonMobil (NYSE:XOM) that have substantial operations abroad will be OK. And since a weak dollar also benefits the price of oil, the majors doubly benefit. Construction and engineering firm KBR (NYSE:KBR), a debt-free $3.6 billion company, does a bulk of its work overseas. And because the bulk of KBR's work comes from government agencies, the company continues to prosper as best as one can during a recession.

Foreign Investing
Another option is investing in businesses located outside the U.S. that earn money in other currencies that are likely to strengthen against the U.S. dollar. But such a move poses some risk because the other currency must appreciate and the company needs to maintain its profitability. So while the Japanese yen has gotten stronger against the greenback lately, many Japanese businesses have a tough time of it.

Nations like Brazil and Australia, which are rich in commodities, are expected to resume a healthy GDP going forward. Up north in Canada, you have commodity giant Teck Resources (NYSE:TCK), which does business all over the world and has the Canadian dollar as the functional currency.

Bottom Line
The market rally continues to propel shares higher, including those mentioned above. It's never wise to make any investment based solely on a single macro bet, especially if the prices aren't bargains. But if the dollar does continue to weaken long-term, then businesses with characteristics like those above will benefit.

What to do about the Falling Dollar (Credit Suisse)

The Dollar Is the First Victim of the Recovery


Joy Bolli, Online Publications Credit Suisse


14.09.2009 Over the last few weeks, stock markets have been performing positively – optimism seems to be back. According to Giles Keating, Head of Credit Suisse Global Economics & Strategy Group, this optimism is based on real facts. However, what is good for the world economy doesn't look to be so good for the dollar.

Joy Bolli: Giles, what's behind all this good news?
Giles Keating: First of all, the economy is recovering more strongly than most people expected – albeit from a very low base: We still have lots of unused capacity and we still have high unemployment, but things are moving in the right direction. Secondly, there is a lot of cash out there. Many investors were left behind given the strength of the early pick-up in the stock market. Now they are wondering if they shouldn't be putting their money to work. And thirdly, the policy makers - central banks, governments - have signaled that they are going to maintain a very expansive economic policy, that they are going to keep interest rates very low for a long time, and that they are going to continue their fiscal spending.


What are the risks going forward?
Clearly, one risk is that this economic recovery won't continue, and some economists are very concerned that things might start to drop off when the current rather strong momentum is over in perhaps two or three months' time. The consensus in the Credit Suisse Economic and Strategy Group is, however, that this risk is not very high. On balance, we think that the recovery will continue, given the expansiveness in monetary and fiscal policies. Another risk is that we could actually see some markets moving ahead too strongly, for example some commodity prices. And that, of course, could create trouble elsewhere.


Does this mean that the next bubble is just around the corner?
I think there is a small risk that there's a bubble around the corner. It's more likely that the problem of a bubble lies perhaps 12 months, 24 months or maybe slightly longer into the future. We do know that the financial markets are very prone to lurch between crash and bubble. The very strong medicine that's currently being administered in terms of very low interest rates is great for getting us out of the slump. But history tells us that it does tend to lead us toward the next bubble. So I think there is a risk, but right now it is more likely that we will see prices tending to move up in a number of areas, though probably not reaching into bubble territory for quite some time.


Amid all this good news, the dollar seems to be in trouble. Just a temporary weakness, or a fundamental problem?
The dollar has seen some big downward movements over the last couple of weeks, and although we think that this won't continue in a straight line, we do think it likely that the dollar will continue to weaken over the next six to twelve months. This can be expected to happen both against the major currencies like the euro and the Swiss franc, as well as against some of the high yielders like the Australian dollar and even some of the emerging market currencies like the Brazilian real. So we are recommending diversification out of the dollar.


What makes the dollar so weak?
Interest rates are, of course, very low in the United States, at almost zero. Although they are low in other countries as well, historically the dollar has needed an interest rate premium - a higher interest rate - than in Europe in order to remain stable or rise in value. Another key reason is that, strangely, as financial conditions get less risky and become more stable, people tend to move out of the dollar. Moreover, a lot of people put money into the dollar during the crisis, and now they have too many dollars. And finally, financial transactions were made by some of the world's major banks at the end of last year since they had to buy dollars in order to square up their balance sheets. That effect is now more or less over. For some banks, this is actually going into reverse, so they are now selling dollars.


Do all investors share this rather pessimistic view of the dollar?
No, of course this is a controversial issue, and I know that many investors, although they recognize the dollar problem, also see problems with other major currencies like the euro. But we believe that there are many financial forces that will boost the euro against the dollar. We would therefore recommend a diversification strategy for those who don't feel entirely confident with the euro. In fact, we consider it a good idea for all investors to diversify broadly into a number of other currencies, as well as – to a lesser extent - into precious metals like gold.

Which industry will surprise us with good news in the next six months?
I think a number of them could, but one in particular that my colleagues and I at Credit Suisse would pick out is the technology sector. We have already begun to see parts of the tech sector move up from very low levels. And as we move forward, there are several very favorable factors here. It's not so much consumer demand, although that could play a bit of a role; rather, it's greater demand from companies that cut back their IT expenditure in a big way during the slump. This, along with some new technologies that are coming through, leads us to think that this sector could perform rather well.


And which commodities will be among the best performers?
We think precious metals can continue to move up. At this current time, gold for example has just broken through the 1000 dollar level, and we think it could certainly head to somewhere around the 1100 level. And some of the other precious metals like platinum could continue higher. We are slightly more cautious about base metals such as copper. We think their inventories have gotten somewhat too high. Regarding oil, some of the bigger countries in OPEC are not keen to see oil get too strong. So we think the trend is up, but perhaps not dramatically so.

What's Next for the Economy: Stocks vs Bonds (Marketwatch)

Bonds and stocks diverge on U.S. economy
By Nick Godt, MarketWatchLast Update: 4:20 PM ET Sep 9, 2009


NEW YORK (MarketWatch) -- For those investors who believe the stock market works perfectly at discounting risks and rewards, the U.S. economy and corporate profits must seem to be on track for a stellar recovery.

After a spectacular 50% surge since March, stocks on the S&P 500 Index ($SPX) have continued rising through the summer and into September.

Yet, the market for U.S. government bonds, considered among the safest assets around, seems to be telling a different story."There is a growing group of people following the view that we'll have a jobless recovery in the economy," said Bill O'Donnell, head of Treasury strategy at RBS Securities.

"They're asking what comes after the sugar-high from the government stimulus measures, and what they see is rising joblessness, consumers spending less and lower inflation. All in all, good conditions for bonds."

On Wednesday, U.S. stocks continued to advance after the Federal Reserve's so-called Beige Book of current economic conditions. The central bank said the economy is improving across most U.S. regions but that consumer spending remains sluggish.

The Dow Jones Industrial Average ($INDU) finished up 49 points, or 0.5%, at 9,547. The Nasdaq Composite (COMP) was up 22 points, or 1.1%, at 2,060, while the S&P 500 gained nearly 8 points, or 0.8%, to 1,033.

Separately, Treasurys turned higher after the Beige Book and after the government's auction of $20 billion worth of 10-year notes was met by ample demand.

Demand for benchmark 10-year Treasury notes surged over the past month, sending their yields (UST10Y) down by about 40 basis points. Bond yields move inversely to price.

Government bonds provide fixed income over periods of time. This means that longer-dated bonds, such as the 10-year note, are more susceptible to inflation as fixed income loses value if prices rise in general.

When bond prices rise and their yields fall, it generally means that the chance of rising inflation is waning -- along with the outlook for economic growth.

Who's right?

Unfortunately for stock investors, bonds have often provided a better gauge of economic trends than equities. A recent example was when Treasury yields began sliding in June of 2007, as defaults on subprime mortgages surged and deteriorating credit conditions led fixed-income investors to seek safety.

Yet stocks continued to rally for another four months, reaching record highs by the middle of October 2007 before taking the big plunge. In those four months, the yield of the benchmark 10-year Treasury bond had already slumped by about 70 basis points.

Perhaps similarly, yields rose sharply for most of this year, as investors abandoned the safety of bonds and jumped into the massive equity rally. But over the past few months, yields have started to slump again.

Strong demand for even shorter-dated maturities, such as the 3-year notes sold at a government bond auction on Tuesday, is now raising doubts about the economic outlook among a number of market strategists.

"What does it say about the view on economic growth that there is such big demand for the 3-year note?" asked Peter Bookvar, equity strategist at Miller Tabak, in a research brief.

"Why isn't this money going into riskier assets? Again, it's another data point of the disconnect between the U.S Treasury market and equities," he said.

The visible hand of government

"The government has got a heavy hand in this recovery," says Jack Ablin, chief investment officer at Harris Private Bank.

Ablin does believe the economy and stocks are still running on the "sugar high" provided by government spending. However, while the bond market may be looking further ahead when the economy might run out of momentum next year, he doesn't believe stocks have to come down.

"There's still 10 donuts in the box [out of 12]," Ablin says. "We've only spent about 10% of the $800 billion or so committed. "The government is still spending a lot of money and that's going to be reflected in the economy and profits at least for the next couple of quarters."

And corporate bonds also continue to improve steadily, he noted.

Meanwhile, government bonds may simply have become a good bet again because of the lack of inflation in the outlook for the economy.

With the government raising close to $2 trillion to help shore up the economy, and as markets took the view back in March that those measures had helped avoid the worst, Treasurys seemed to be a bad bet for most of the year, and yields surged along with stocks.

Some of the hesitations on the way up were that government spending would pressure the dollar and boost inflation, and that raising money might become harder as buyers of U.S. debt, including foreigners, would become more scarce.

But while the dollar has returned to its lows of the year, few believe inflation is in the cards as long as the economy continues shedding jobs, and consumer spending, which makes up for about 70% of the economy, remains muted.

And judging by the results of this year's auctions, demand for U.S. government bonds remains strong.

For Ablin, if there's one area where a weak dollar has led to too much speculation, it's commodities, including gold topping $1,000 an ounce.

"I'd think twice before melting down your Rolex," Ablin said.

Investing - the New Normal (Bloomberg Opinion)

Gross, Grantham, Bogle Lift Lid on ‘New Normal’: John F. Wasik



Commentary by John F. Wasik

June 1 (Bloomberg) -- If this past year has taught investors anything, it is that conventional wisdom has suffered a thousand cuts.

Stocks don’t always beat bonds. It may not make sense to always have 60 percent or more in stocks and 40 percent in bonds. Stock markets may actually reward politicians.

Three pallbearers of the established canon are Bill Gross, the co-chief investment officer of Pacific Investment Management Co.; Jeremy Grantham, chairman of GMO LLC; and John Bogle, founder of Vanguard Group.

All are beacons in a troubled industry. When I caught their talks at the Morningstar Inc. investment conference in Chicago on May 28, I expected to hear dour forecasts. Yet I didn’t expect notes on the revolution that is undermining the beliefs that investors held during growth eras.

Gross, the world’s most successful bond-fund manager, described what his firm calls the “new normal” investing environment. While he sees “accelerating inflation” toward the latter part of a three- to five-year cycle, he says almost every accepted notion about investing should be examined.

Weak earnings growth translates into “getting used to a 301(k)” -- as opposed to a robust 401(k) -- retirement fund. Stocks won’t always outperform bonds and having dominant positions in equities may not make sense.
Changing Outlook

In Gross’s outlook, the dollar will lose its status as the reserve currency; Brazil, India and China (forget Russia) will offer the best growth; and the U.S. is “consumed out.”

“Everything in this new normal world should be questioned,” Gross said.

What is normal? Certainly not an environment that rewarded investors with 10 percent returns in stocks every year as Wall Street said it would before the dot-com, housing and credit crashes dashed that myth.

That means the accepted wisdom of having 60 percent to 80 percent in stocks may be obsolete and unprofitable. The only guarantees are that the U.S. government will be selling trillions in Treasuries; Americans may start seriously saving again; and the consumer economy may be shrinking long term due to the aging of the population.

Grantham, whose bearish views can often be amusing in the way he presents them, sees some reasonable values in the stock market now, although he’s not sure that a robust rally is in the offing. He also warns that “you can bet on” a bubble forming in emerging-markets stocks.
Grantham’s Optimism

Like many observers, Grantham also sees Americans saving more and consuming less.

“We forgot to save in the last decade because of home prices,” he said. “Now we’ll have to work longer and be more frugal in order to retire.”

Grantham’s only palpable stock-market optimism -- always in short supply in his forecasts -- is the third year of a U.S. presidential cycle.

“Historically, year three has outperformed years one and two by about 22 percent,” he noted. “And there’s never been a major bear market in year three of a presidential cycle.”

For most of us stung by the wretched returns of last year, though, 2011 is too long to wait. That’s why I prefer Bogle’s fundamental approach to portfolios. It doesn’t involve any charts and almost no forecasts.

Bogle says his formula is based on one’s age. The older you are, the more you should have in bonds, approximately matching a percentage of fixed-income investments to your age.

Sage Advice

As one who mostly takes his own advice, Bogle said his allocation produced only an 11 percent loss in his portfolio last year when others with higher percentages in stocks lost from 30 percent to 50 percent.
Of those who got scorched last year, “98 percent of all investors would be willing to swap places with me,” Bogle said.

In keeping with his bedrock views that passive investing through low-cost index funds prevails over time, Bogle eschews absolute return and commodity funds.

What each sage investor neglected to mention was an ever- greater need to customize portfolios not only to hedge market risks but personal labor-market risks as well.

Are you in a profession or industry that’s wobbly right now? Do you have the resources to retrain or re-educate yourself? At the very least, your savings and investments should support some vocational flexibility in these dynamic times.
That’s perhaps the only piece of conventional wisdom that hasn’t changed.

(John F. Wasik, author of “The Cul-de-Sac Syndrome,” is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: John F. Wasik in Chicago at jwasik@bloomberg.net.

Last Updated: June 1, 2009 00:00 EDT

Safety First (from Barrons)

Monday, September 15, 2008




Retirement: Safety First
By KAREN HUBE

Risk experts explain how to keep your nest egg from cracking in shaky markets. Also, which investments offer the most stable returns during slumps? And, exotic real estate -- with an American twist.

THESE ARE SCARY TIMES FOR INVESTORS TRYING to protect and increase their retirement portfolios. With stock prices gyrating and major financial institutions crumbling, the mattress may look like as good a place as any to stash your holdings.

Not so fast. Take it from five titans of risk management: There are steps you can take to protect your nest egg for as longs the tumult lasts -- steps that will make sharp market dips much easier to endure.

Even better, without sacrificing those safeguards, you can position your retirement funds to participate in the earliest gains as the stock market begins to recover. And yes, these experts say, the market will recover.

So heed the practical advice and recommendations of the intellects whose views you'll read on the following pages -- Barton Briggs, Peter Bernstein, Charles Ellis, David Darst and Jeremy Siegel -- and reserve that mattress for some peaceful sleep.


Brad Trent
Peter Bernstein
Founder, Peter L. Bernstein Inc.

After almost six decades of contemplating market risk, Peter Bernstein knows how to spot investors' worst-case scenarios before they do. These days, what he sees concerns him deeply.





As the current economic crisis unfolds in ways that even the most bearish Wall Street strategists never predicted, Bernstein says any number of disasters could still be in store for investors. For those saving for retirement, in particular, taking protective measures is critical.

"The goal for investors right now should be survival, not making a killing," says Bernstein, who has been an economics professor and money manager, and is the author of several books, including Against the Gods, a classic on risk. "You should be thinking about how to hedge against extreme outcomes."

With markets down and unemployment and home foreclosures rising, what more could happen?

"A major bank failure, causing a run on banks in general," Bernstein speculates. Or "a run on the dollar, perhaps provoked by what foreigners view as too big a fiscal deficit."

Or runaway inflation or deflation, either of which could be disastrous for long-term retirement investors.

The next step of this crisis is hard to predict, Bernstein says, because the crisis is so unusual. "Nothing like this has ever happened before," he continues. "There have been credit crunches and housing crises and dollar crises, but having all the chickens coming home to roost at the same time and interacting with one another is unique. We have historical perspective on the parts, but not the whole, and that makes things both interesting and scary."

He suggests diversifying a portfolio so that it is not only exposed to many different markets, but also to ensure it can weather all kinds of scenarios.

For example, to guard against rampant inflation, every portfolio should contain at least a sprinkling of Treasury inflation-protected securities and short-term Treasuries, Bernstein suggests.

The TIPS come with a guaranteed return above inflation, and short-term Treasuries enable you to roll your money into higher-yielding issues every 90 days if inflation rises and interest rates follow.

"Short-term Treasuries aren't a very good holding under normal conditions, but they are a hedge against extreme conditions," Bernstein says. Long-term Treasuries are a good hedge against deflation, he adds.

Bernstein also recommends holding some gold as a hedge against a collapse in the value of the dollar if China or other nations decide they no longer want to invest as much in U.S. Treasuries. "In a total disaster, where there is a run from paper currency, you'll get your biggest bang for your buck in gold," he says.

You don't have to buy much gold to have an effective hedge, he adds, noting that "if everything hits the fan, gold could be worth several thousand dollars an ounce." It is now valued at about $750 an ounce.

Above all, don't let your defensive attitude waver, Bernstein counsels.

"Every day, we are faced by the possibility that something we never dreamed of will happen," he cautions.

"In 1958, I'd been in the business for seven years when, for the first time in history, bonds yielded more than stocks. My associates said, 'It's an anomaly, don't worry, it will be reversed.' It's 50 years later, and I'm still waiting."


Gary Spector
Charles Ellis
Founder, Greenwich Associates

In Japan, investors fill their stock portfolios primarily with Japanese companies. The French place their biggest bets on French companies. The story is the same in New Zealand, India, Russia, and around the globe: Investors favor their own countries' stocks.

For U.S. investors it's easy to criticize foreign investors for being provincial. But Charles Ellis, a former chair of Yale's Investment Committee and a consultant for institutional investors, has a suggestion for them: Look in the mirror.

The typical U.S. investor holds at least 85% of his stock portfolio in domestic stocks, even though the U.S. stock market accounts for only 40% to 45% of the world's total stock-market value.

"People feel more comfortable emphasizing their own country, because they recognize the company names," says Ellis, whose internationally renowned book is Winning the Loser's Game. "But from a pure investment point of view, it doesn't do any good" -- particularly for folks investing for retirement and other long-term goals, he says.

A U.S.-centric stock portfolio creates high levels of volatility, and denies investors the benefit of surging markets around the world, Ellis notes.

The best risk-adjusted returns over the long term can be scored by matching the market capitalization weightings of the world's markets, Ellis says. That would mean putting 45% in domestic stocks, 47% in developed foreign markets and 8% in developing foreign markets.

The idea is to have no bets on whether one market or another will be stronger in coming months.

"If you said, 'I don't really have a smart idea about the direction of the markets, I'm just a sensible person, what should I do?,' the answer is to go to a global index and start there," Ellis says. "If you have reason to make any changes from there...then you can adjust it from a neutral to an opinionated portfolio."

Traditionally, investors have been hesitant to plunge more deeply into foreign markets -- because of perceptions that foreign-currency exposure presents too much risk, foreign companies don't get enough oversight from their governments, and foreign markets are simply too volatile.

To Ellis, however, the truly global allocation of assets trumps all those concerns.

"There really is a free lunch, and it's called diversification," he says. "By diversifying, you reduce your risk substantially. It doesn't cost anything, and you get something for it."


Evan Kafka
Barton Biggs
Managing Partner, Traxis Partners

When the herd zigs, Barton Biggs zags. So it shouldn't be a surprise that while U.S. investors can't dump their technology stocks fast enough these days, Biggs has been declaring that now is the time to get into the trampled tech sector.

The best values right now, he says, are in large-cap, high-quality stocks around the world, "but particularly in the U.S., and within that category, technology appeals to me the most."

Biggs, co-founder and managing partner of the $1.3 billion hedge fund Traxis Partners in New York, is the former global investment strategist at Morgan Stanley.

"We've been in a period of stagnation in terms of tech spending since the bubble burst in 2000. The next recovery is going to be marked by unusual spending in all types of technology...and the sector will be one of the first areas to pick up as the U.S. and the world begin to recover," Biggs says.

A market recovery, he believes, will begin in the first half of 2009. By then, oil prices should be consistently below $120 a barrel, and the housing market should have started stabilizing.

Due to the government's takeover of Fannie Mae (ticker: FNM) and Freddie Mac (FRE) -- which he characterizes as "one of the most important events of the last 20 years" -- further declines in home prices are likely to be more moderate than expected earlier.

But don't wait for an economic recovery in order to step into large domestic stocks and global tech stocks, or "the markets will already be up," Biggs says. "I wouldn't be surprised if later, in retrospect, we will find that the stock market is at its bottom about now."

Biggs is a notoriously trend-bucking strategist, which has sometimes paid off massively for those who follow him. In the late 1990s, he spared his clients huge losses by predicting the technology-driven bull market was going to plummet. And in 2003, when investors were steering clear of Japan, he moved into the Japanese stock market, adding untold wealth to clients' portfolios in the following three years as Japan soared.

Today, while many Wall Street strategists are recommending an underweighted position in stocks, Biggs is defiantly upbeat." The public has been selling stocks and has an incredible amount of liquidity, and so have institutions and hedge funds," he says.

"The fact that everyone is cautious has raised a lot of investable funds, and that's bullish," he adds. "We're in a stage where ordinary investors ought to be buying on weakness," says Biggs.

Some of his top picks: Cisco (CSCO), IBM (IBM) and Google (GOOG).

Biggs is steering clear, for now, of stocks in the materials, energy, agricultural and industrial- and oil-commodity sectors, but notes that "those will come on strong again -- but not until further into the recovery."


Dave Moser
Jeremy Siegel,
Professor, Wharton School

To most investors, dividend-paying stocks seem about as cutting edge as a corded telephone. Yet Jeremy Siegel talks about stock dividends with the enthusiasm and sense of discovery of a first-time iPhone user.

Through his recent research, Siegel, a finance professor at the University of Pennsylvania's Wharton School of Business, has become enamored of the dividend, and hopes to elevate its status from a humdrum staple for retirement-income seekers to a punch-packing contributor to younger investors' retirement portfolios.

He argues that the tendency of investors to look solely at the growth rates of earnings, sales and cash flow hurts them in the long run. The bias toward high-growth companies causes them to miss out on the high dividend-paying companies whose total returns, contrary to popular perception, have historically outshined the performance of growth stocks over time, he says.

"Everyone thinks it's old-fashioned to think about dividends, but investors have historically gotten about an extra two or three percentage points a year of higher returns by investing in the highest dividend-yielding stocks and reinvesting the dividends," says Siegel, author of The Future for Investors, Stocks for The Long Run, and other books.

One of his most striking examples is the difference in fortunes between people who invested in IBM rather than Standard Oil, now ExxonMobil (XOM), in 1950. Over the next five decades, through 2003, IBM trounced Standard Oil in per-share growth of revenue, dividends and earnings. But Standard Oil had a higher total return: A $1,000 investment in Standard Oil would have grown to $1.26 million with dividends reinvested, compared to $961,000 -- 24% less -- for IBM investors. "And that was before the recent energy price increases," Siegel says.

While financial companies historically have been reliable dividend payers, the dividends on Fannie Mae and Freddie Mac have been halted, and 21 financial-services firms have cut their payouts since the beginning of this year, according to Standard & Poor's. In a typical year, two or three financial firms cut their dividends, but the majority of them increase their payouts.

Long a supporter of index investing, Siegel now favors index funds that rebalance on a dividend-weighted basis. Siegel is a senior investment strategy adviser at WisdomTree, which has developed a series of funds that operate this way.

A dividend-weighted index rebalances regularly to favor stocks that pay the highest dividend. Most indexed portfolios, in contrast, rebalance based on the market capitalization of the stocks. With a dividend-weighted index, investors end up buying stocks when their prices are low relative to their fundamentals. A high dividend yield is a strong indication that a stock is undervalued, Siegel says.

Throughout history, dividend-paying stocks have gotten the spotlight. When the tech bubble burst in 2000, many investors sought out dividend-paying stocks to try to steady their portfolios. In 2003, payouts got a boost when the tax rate on dividends was changed to the 15% capital-gains rate, versus the higher income-tax rates.

Some of this tax benefit may get rolled back if Sen. Barack Obama (D.-Ill.) is elected president; he has said he would raise the dividend tax rate to 20% -- "but that's still a preferred rate," Siegel points out. He adds that investors who keep a steady spotlight on the high dividend-paying stocks in their portfolios are likely to have a brighter retirement.


Gary Spector
David Darst
Global Wealth Management Group,
Morgan Stanley

David Darst is the Iron Chef of the investment world. As chief investment strategist at Morgan Stanley's Global Wealth Management Group for the past 11 years and one of Wall Street's foremost experts on asset allocation, Darst spends much of his time considering the perfect ingredients -- of a portfolio, that is. He takes a little of this, blends it with a little of that, and -- voilà! -- produces nourishing retirement portfolios.

Investors who have seen the air sucked out of their retirement portfolios lately might need convincing. The problem in the typical portfolio, Darst suspects, is that most people skimp on alternative investments like commodities, real estate and hedge funds.

"The perception is that they're too risky, but we view the benefits of alternatives more by the reduced volatility they bring to a portfolio than by an increased return," says Darst, who recommends that folks with $1 million to $20 million to allocate 20% to alternative investments, and those with less, 8%.

While any particular alternative investment may, indeed, be more volatile than the broad stock or bond markets, a portfolio diversified across stocks, fixed income, and a number of different alternatives will likely be less risky than one with fewer asset classes -- and it may even score higher returns, Darst says.

Consider a portfolio with 40% invested in stocks and the rest split between commodities and real estate. That may sound risky, but according to Ned Davis Research, in the 35 years through 2007, such a portfolio had the same risk as a portfolio with 40% invested in stocks and 60% in bonds. Yet it gained almost two percentage points more per year -- 12.47% versus 10.5%.

Within an alternative-investment portfolio, Darst recommends a 50% weighting in hedge funds, which gives investors the potential to benefit from talented money managers who have the freedom to invest where and how they see fit, without constraint.

Some 20% should be in real assets, such as commodities and gold. Both provide a hedge against inflation, and gold in particular has been a historic refuge in times of turmoil in the financial markets, political instability, or other crises.

Another 20% should be directed to managed-futures funds, Darst says. These invest by going long or short futures contracts in a broad basket of commodities and other investments, including metals, grains, sugar, foreign currencies, stocks and bonds.

Managed-futures funds provide a cushion to portfolios in down markets, because they typically are inversely related to the stock market, Darst says.

During the period 2000 to 2002, when the tech bubble burst and the Standard & Poor's 500 cratered 31%, the Barclay CTA Index of Managed Futures Funds was up 20%. In the fourth quarter of 1987, when the U.S. stock market crashed and the S&P 500 lost 22.5%, the Barclay index was up 13.8%. This year through August, the S&P 500 was down 14%, while the Barclay index was up 6.95%.

Lastly, Darst recommends placing 10% of a portfolio in Treasury inflation-protected securities to get their risk-dampening benefits, Darst says.

While he has usually included real estate in the alternative-investments portfolio through direct investments or REITs (real-estate investment trusts), he predicted enormous volatility in the sector last December and made a tactical move to eliminate real estate from his models.

For the average investor, however, it would take a rare event to prompt the removal of an asset class from the alternative-investments portfolio, because that could mean missing its next surge.

Says Darst: "You want to have all of your relatives at the table. Not just the 17-year-old singer in the family that everyone has always listened to, but the quiet nephew who turns out to win the Pulitzer Prize."

Follow advice like that, and investors themselves just might take home a prize.


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Investing in Commodities (from WSJ)

Commodity-Based Funds Earning Favor
Corn or Oil in ETFs
Can Add Stability,
But Ratios Matter
By IAN SALISBURY
August 14, 2008; Page C13

Investors have taken to commodity exchange-traded funds, but choosing a fund isn't easy: Design hurdles mean seemingly similar funds can have quite different holdings -- and different returns.

Most stock indexes weight companies based on market capitalization, or the total value of their shares outstanding. This calculation isn't feasible for commodities, so index designers have to estimate or take an entirely different approach -- and they come up with widely varying results.

To take one example: The iShares S&P GSCI Commodity Indexed Trust has 78% of its assets in energy and just 2% in precious metals, according to a recent report by Morgan Stanley.

As a result, this ETF has shot the lights out over the past year, gaining 40% despite the recent decline in oil prices. By contrast, the Greenhaven Continuous Commodity Index ETF has 47% of its assets in agriculture and just 18% in energy. It's up 2% since hitting the market in late January.

Other commodity index funds have splits that lie between these two extremes.

Commodity ETFs and their close cousins, exchange-traded notes, have been gaining traction with investors, collecting more than $40 billion since the first one hit the market in 2004, according to Morningstar Inc.

Commodity Cushion

As events this summer have shown, prices for goods like oil and corn can surge even as stocks plunge. Many financial advisers now believe keeping a small portion of investors' assets in commodities can smooth a portfolio's overall volatility.

"Most people use commodity ETFs as part of their asset allocation" plans, says Kevin Rich, managing director at Deutsche Bank AG, one of the companies that offers commodity ETFs. "We see people with 1%, 3%, 5% in commodities."

While it's relatively easy to decide what to include in commodity indexes -- usually crude oil, agricultural goods and precious metals -- it's difficult to come up with a rationale for how much to include of each one. It's not as simple as with stock indexes, which typically go by market value of the companies.

One solution is to estimate how much of a commodity is produced a year. The purest production-oriented approach is taken by the S&P GSCI Index, which bases weightings on average production levels for 24 commodities over a five-year period.

"Commodities aren't like equities," says Eric Kolts, director of commodity indexes at Standard & Poor's. "The closest you can get to market capitalization is what we do with production."

Two Barclays PLC investments, $1.1 billion iShares S&P GSCI Commodity Indexed Trust and $292 million iPath S&P GSCI Total Return ETN, are based on this benchmark. A drawback for many investors, however, is that this method puts a big focus on oil, which represents more than 70% of the index.

Lowered Energy

For that reason, two other investments, one from Barclays and one from Deutsche Bank, have attracted more money from investors by tweaking their methods to reduce energy exposure. The $3.9 billion iPath Dow Jones-AIG Commodity Index Total Return ETN bases weightings on production and trading volumes but caps energy exposure to 33% once a year in January. It's currently drifted up to about 36%. (News Corp.'s Dow Jones & Co. publishes The Wall Street Journal.)

The $3 billion PowerShares DB Commodity Index Tracking Fund is based on production and inventory levels, but designers also "redistributed some of the exposure from energy into metals and specifically precious metals" to make it more diversified, according to a spokeswoman.

About 61% of the ETF is in energy, according to the Morgan Stanley report.

Finally, the above-mentioned $29 million Greenhaven Continuous Commodity Index ETF puts the entire focus on diversification, doing away altogether with the notion that the fund ought to reflect a commodity's role in the economy. It weights 17 commodities, including gold, orange juice, and crude oil, equally.

Because so many individual commodities are agricultural, these represent almost half the index, according to Morgan Stanley.

Write to Ian Salisbury at ian.salisbury@dowjones.com