INFLATION, VOLATILITY & OIL
By Richard L. Kesner, President
The CommonWealth Group
May 2008
With Core inflation currently at about 4.1%, real inflation, including energy and food, has increased to between 8% and 9% per year. In a prior newsletter we mentioned that the cost of staples like wheat, rice and milk has soared year over year causing a net negative loss for fixed income investors.
Historically the only investment, (including oil, natural gas, gold, bonds, real estate etc) that has outperformed inflation is equity investments. Any portion of the total portfolio that is allocated to fixed income investments causes an asset allocation to equities that is more aggressive than necessary to make up for the loss of return from the bonds. The problem is the volatility of the equities is greater than the volatility of the fixed income investments.
THE GOOD NEWS ABOUT VOLATILITY
Volatility is a necessary factor to experience equity like returns. It is this point that is crucial in designing portfolios to meet client goals. Most investors ignore volatility during periods of positive market returns. However, volatility works both ways. As we have experienced over the past year volatility can be heart wrenching, gut wrenching and outright evil. The equity investor (a) must be long term and (b) must be able to withstand these periods of negative volatility in order to achieve his goals. Without the volatility we would not be able to outperform inflation and we would be losing money daily with no hope of achieving our goals. With volatility we have a chance of achieving our goals.
This is one of the best times to invest in equities. We believe that while the volatility will continue (and may even get worse) that the problems that currently persist in the US economic system (subprime, credit, inflation, oil, energy….) will eventually be resolved. Ownership in the great companies of the world will provide huge benefits to the investor who can withstand the peaks and valleys.
Bonds provide a guaranteed rate of return and a return of principle. Investors lend money to a company and receive a fixed rate of return. This type of investment is less volatile than equities. Through the use of alternative investments we have been able to design portfolios that reduce the volatility of accounts while still providing returns that are better than the fixed income investments currently available, and maybe even better than inflation. The difference is these returns are not guaranteed while the bond returns have a guarantee, the full faith and credit of the issuing company. Some investors however, may remember that companies like Enron defaulted on their bonds. The only real guarantee we have is in US Government Bonds.
IBEX FUNDS
We currently manage three funds of funds for investors. Ibex Growth is a Growth fund, Ibex Absolute is an Absolute Return Fund and Ibex Income provides alternative sources of income for investors. This strategy when blended together provides an investor with a portfolio of 25 foreign and domestic managers, many of them non-correlated to the market. For the first quarter of 2008 a blend of 25% Ibex Growth, 50% Ibex Absolute & 25% Ibex Income provided a net return of -1.92% (Past performance is no guarantee of future results) vs. a return of -9.55% for the S&P 500.
The above chart is based on the historical performance of the Ibex Funds with the existing managers. Past performance is no guarantee of future results. Manager selection within each fund may change in the future. Information regarding any of the Ibex Funds is available upon request.
OIL AND THE DOLLAR
For more years than we can remember the US dollar has been the safe haven of all currencies in the world. Countries would park trillions of dollars of assets in the US because they had no fear that this money would disappear. In return they received a guarantee fixed rate of return. This is still happening today, but to a lesser extent. The continual reduction of interest rate by the FED has caused many countries to reexamine holding a huge portion of their reserves in US dollars.
Other currencies like the Euro, Yen & Swiss Franc do not have the liquidity or capacity (float) that is large enough to support the trillions of dollars that need to be placed. The other “currency” that has emerged is oil, either in the commodity or in oil futures. We believe that foreign countries are using these futures to hedge the devaluation of the dollar and this is a chief cause of why oil is trading at around $115 per barrel. Don’t be surprised to see these futures come down and the dollar increase in value. Smart investors take profits before the top and buy bargains (like the dollar at low values). If the flows materialize the dollar is sure to rally.
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