Investor Spring Cleaning 2008

Alternative Investments Become Staples

Shelly K. Schwartz,|Special to

If you believe what you hear at the investment seminars these days, there’s never been a better time to snap up alternative assets, especially commodities and commercial real estate.

These Investments (think gold) are now riding a wave of popularity and have long been prized for their low (and sometimes negative) correlation with stocks and bonds – meaning, they tend to zig when equities and fixed income zag. That helps minimize volatility and, theoretically, reduces portfolio risk.

“Every planner under the sun is recommending commodities right now,” says Christine Benz, director of personal finance for mutual fund tracker Morningstar. “It’s the kind of thing that tends to swing in and out of favor” depending on how the Street performs.

Beyond the benefits of diversification, of course, commercial real estate and commodities have also become the belle of the ball because they provide a hedge against inflation – a growing concern among many economists as the cost of education, energy and, more recently, food edges higher.

In the case of commodities, which are raw materials (wheat, cattle, gasoline, gold and oil), the reason is simple: As the price of goods and services rises, the price of commodities needed to produce those goods and services climbs as well.

Likewise, rental fees for commercial property, including retail and office space along with apartment complexes, tend to rise in an inflationary environment, says Mitchell Roschelle, national real estate advisory practice leader for auditing and advisory firm PriceWaterhouseCoopers.

“In periods of inflation, typically rents go up and that drives values up,” he said. “That’s been the theory.”

Proceed With Caution

So, given current market pressures, then, is it wise for individual investors to up their exposure to such investments? It depends largely on one's tolerance for risk, says Roschelle.

“Alternative investments, or non traditional assets, tend to be for those which have a greater risk appetite because the fluctuations in value tend to be more dramatic,” he says.

That said, he notes, the blue chip stock indices have been “bouncing around all over” for the last couple years, while commodities, like energy and grains, have been registering “nothing but a straight line up,” giving credence to the theory that commodities can smooth out the bumpiness of your overall portfolio.

As of April 25, the S&P GSCI Commodity Index was up 22 percent for the 12-month period and 57 percent over the last three years. The Dow Jones-AIG Commodity Index returned about 27 percent and 15 percent for the 12-month and 3-year periods, respectively.

By comparison, the S&P 500 index has lost 4.2 percent over the last 12 months but returned nearly 21 percent over the last three years. The Dow Jones Industrial Average is down 2.8 percent in the last year but up 27 percent over the last three years.

Despite the short-term success of commodities and commercial real estate, however, Mitchell and Benz agree these asset classes should make up only a small percentage of your overall portfolio.

“The key is to keep them to a fairly small percentage of your investment holdings – somewhere between 5 percent and 10 percent," says Benz.

Anything more may be wishful, if not reckless. As is often the case with investment trends, by the time Main Street investors get to the punch bowl, the party is usually over.

Buying Commodities

You can invest in commodities by buying futures contracts, of course, which are basically an agreement to buy or sell a specific quantity of a commodity at a specified price in the future, or by purchasing an option on a commodity futures contract, which gives you the right to convert your option into a futures contract.

But for average investors, the easiest (and least risky) way to add exposure is to purchase a commodity index fund.

Commodity exchange traded funds (ETFs), which are traded like stocks, track the price of either a single commodity, such as wheat or oil, or a bundle of commodities, like a mutual fund.

Commodity exchange traded notes (ETNs), meanwhile, are not funds at all but 30-year debt securities which track the major commodity indices. Investors can buy and sell them through a broker on the New York Stock Exchange.

“I think that’s partly why we’ve seen such an increase in popularity for commodities,” says Benz. “It’s easier than ever to buy a well diversified basket of commodities.”

Currently, Morningstar recommends PIMCO Commodity Real Return Strategy and iPath Dow Jones-AIG Commodity Idx TR ETN   .

Investing In REITs

The commercial real estate industry offers a similar vehicle for small investors – real estate investment trusts (REITs), which are companies that own or operate income-producing property such as apartments, shopping centers, offices and warehouses.

Not only do REITs help diversify your investment in commercial real estate, but they are also required to distribute at least 90 percent of their taxable income each year to shareholders, creating a reliable dividend income.

Yet, REITs these days are also a volatile bunch. After beating the major market benchmarks for seven years straight, profit taking and the credit crunch have taken their toll.

The NAREIT All REIT Index lost nearly 18 percent in 2007, after putting up a 34 percent gain in 2006. So far this year, it’s up 8.8 percent through April 25, according to the National Association of Real Estate Investment Trusts.

“REITs had been up so much in the previous years that maybe it was time for a little profit taking, but they’ve been good for the most part so far this year,” says Robert McMillan, industry analyst for Standard & Poor’s.

Retail REITs, in particular, he says, which own shopping centers, are positioned for steady growth in the coming months, since rents are negotiated under long-term contracts making them somewhat insulated from the ups and downs of retail performance.

His top pick for retail REITs: Simon Property Group .

Commodities and commercial real estate may help diversify your portfolio and even hedge against inflation, but they can also swing pretty hard in either direction. So be prepared for a bumpy ride.