President & CIO explain how one fund layers commodity exposure onto an equity index and why that overlay seems to be working now
Fear and greed might be an unhelpful binary in moments when markets hit historic highs and multiples get expensive. Looking at US markets right now there’s a case to be made that these emotions are not mutually exclusive. Investors are greedy, in that they’re still seeking out the AI-theme that is driving US tech companies and overall US market indices to new heights. They’re fearful, too, both of a downturn in that theme and of missing out on a further run. So where can advisors turn when US equities are still driving higher, but so many signals are screaming diversify.
Tim Pickering believes he has the right product at the right time. The Founder, President, and CIO of Auspice Capital Advisors highlighted the Auspice One Fund, a publicly available liquid alternative (NI 81-102) fund that tracks both the S&P 500 and the Auspice Diversified Fund, his firm’s flagship long/short commodities strategy. Auspice is, first and foremost, a commodities manager aimed at providing access to meaningful diversification and non-correlated assets. The nature of commodities investing, he explains, allows for the addition of index exposure.
“The benefit for commodities fund managers in this space is that we use futures as our tool, so we don’t need much capital to create exposures. Futures are liquid instruments and they trade on margin. You can gain a big diversified pool of assets, everything from cotton to crude to coffee to canola, without having to use much capital to gain the exposure,” Pickering says. “We take that extra capital and use it to gain beta to the S&P 500.”
It’s an overlay that Pickering notes has outperformed the S&P 500 for the past five months, post the tariff tantrum, and despite positive performance on that index. He notes that a reallocation by institutions towards commodity exposures as well as pickups in certain key commodity segments have helped drive that alpha. The idea, too, is that in a normal equity downturn the commodities exposure would act as a non-correlated hedge to help outperformance. It’s a strategy that Pickering will quickly admit is not without risk.
Pickering notes that there are scenarios that can create short-term correlations between certain commodities and equities. A short-term shock to the global economy, like the announcement of ‘liberation day’ tariffs by the United States, could see both the equity index and the non-correlated commodity hedge fail to perform. On the whole, however, Pickering argues that the diversification offered by long/short commodities can make more sense in this environment than the traditional hedge investors use against equities: bonds.
2022 is arguably the most acute example of accepted wisdom being thrown out the window. Under conditions of high inflation and resulting rate hikes emerging from the COVID-19 pandemic, equities and bonds fell roughly in lock-step. Pickering notes that in periods of normal inflation, the non-correlated relationship between equities and bonds tends to soften. The justification for a 60/40 equity/bond split, he argues, was a sustained multi-decade period of low inflation. That period now appears to be over, and Pickering believes commodities can do what bonds can’t.
The importance of non-correlation may appear particularly timely now, in Pickering’s view, as US equity markets appear more and more concentrated in their exposure to the AI theme. According to data from Polygon, nine of the 11 largest companies on the S&P 500 are directly exposed to AI, either as hyper scalers, software providers, or chip manufacturers. Those nine companies comprise over 38 per cent of the total market capitalization of the S&P 500, meaning an investment into a so-called broad index fund has a significant concentration in a tiny number of mega-cap technology names.
Commodities come with some exposure to that theme, too. Whether that is the use of copper to wire data centres, natural gas to heat them, or uranium for new nuclear plants dedicated to powering the immense computing required in AI. Other commodities, however, have none of that exposure. Cocoa and canola are not tied to AI and when investors are seeking forms of diversification away from this one giant theme, a wide basket of commodities can help.
Pickering stresses that commodity performance doesn’t end up looking like equity markets. Prolonged flat periods are interspersed with pops in either direction before the cycle resumes again and the commodity moves higher long-term. Broad exposure, he notes, can help with moderating out those independent cycles in commodities and instead offer a largely non-correlated hedge against equities going into an uncertain future.
“We don't know what's going to happen. For all we know, the economic machine of the United States keeps going because they want to fight stagflation. They want growth. They're OK with a bit of inflation. It would appear they're lowering rates, not raising them. So we want to participate. This fund is a way to still hold your equity beta exposure the same as you have,” Pickering says. “Maybe you're getting a little worried that it's gone a little far. This allows you to still hold that equity beta exposure. And for the same dollar you put in that to get the non-correlated asset. We can't say it's a perfect hedge because it's not. But a non-correlated asset… We can look at the factors and say, we're in this inflationary world, we've got a lot of risks, We want something that yins when other things yangs, but we don't want to take money out of the stock market because it's been good.”
