Commodity fund investors need to be careful , say analysts

Investors don’t usually complain about volatility when an asset is skyrocketing in value. Witness the surge of money in recent years into commodity funds...

Investors don’t usually complain about volatility when an asset is skyrocketing in value. Witness the surge of money in recent years into commodity funds, which are intended to reflect the price movements of basic materials like oil, gold and copper — all notoriously volatile assets.

But this spring, some fund shareholders who were relatively new to commodity investing learned at first hand how wildly prices can gyrate. Now the tide of new money into these funds may be ebbing.

‘‘I think people realised that there is some risk, it’s not a one-way street,’’ said Bill Miller, manager of the Legg Mason Value Trust, who had sharply criticised the stampede into commodities in a note to investors at the end of the first quarter. In a recent interview, Miller said the earlier enthusiasm for investing in commodities reminded him of the race into technology and Internet stocks in the late 1990s.

‘‘There’s a reason to own commodities, and then there’s a time to own commodities,’’ he said, adding that he didn’t disagree with the idea of owning some for diversification.

Unlike natural resources funds, commodity funds don’t own shares of the public companies that do the mining or drilling for raw materials; rather, the managers use derivatives to try to mimic movements of commodity indices. That’s why these funds can help diversify a portfolio focused on stocks and bonds, said Karen Dolan, an analyst at Morningstar.

‘‘There are great arguments for including commodities in small doses,’’ she said. ‘‘But investors should be sure they’re willing to stick it out through thick and thin, because these funds are volatile’’. Dolan says commodity funds can lower volatility in a portfolio over time, because they don’t usually move in lockstep with stocks and bonds.

Another significant difference among the funds is in how they invest their cash. Whether the funds use swaps or notes, they still hold on to the capital during the contracts. This is generally invested in bonds, but funds manage the fixed-income parts of their portfolios differently.

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In general, Dolan recommends that most individual investors limit commodities to 5 to 10 per cent of their portfolios. After several years of commodity price gains, she said, some investors may need to trim their holdings to keep them in that range.

If you are weighing a plunge into commodities, she advised check your stock portfolio first. ‘‘Timing commodities is very difficult. It’s not like a good year is always followed by a bad year, or vice versa. I would just advise being careful,’’ she said.

–J. ALEX TARQUINIO