Rising Tides in Commodities

DWS Enhanced Commodity Strategy Fund

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Feb 01, 2011
  • 52 Week HL
    191.57 - $140.85
  • Net Assets
    $2550 M
  • Expense Ratio
  • Inception Date
    Sep 15, 1997

Q:  How has the fund evolved since inception? A : Back in early 2005, DWS Investments launched the DWS Commodity Securities Fund. The Fund passively invested in the Goldman Sachs Commodity Index, along with investing in commodity-related securities, but we found there were some structural issues associated with its investment mandate. The first was that the Goldman Sachs Commodity Index, which has about 70% of its weight on energy, was much more volatile with standard deviations in the high 20% range. Second, passive commodity indices have a lot of inefficiencies, for example, their allocations are static, so investors have similar energy exposure regardless if a barrel of oil is trading at $35 or $135. Finally, the commodity stocks the Fund was investing in were becoming more correlated to the S&P 500 Index and providing less diversification benefits compared to direct commodities. Despite strong relative performance, at the beginning of 2010, we got rid of stocks and started actively managing a more diversified portfolio of direct commodity investments, utilizing time tested models that had been developed on Deutsche Bank’s Capital Market’s side of the business. We renamed the Fund the DWS Enhanced Commodity Strategy Fund. We feel our models differentiate us from other funds by focusing on quantitative and technical factors and take advantage of them relative to the benchmark. Q:  What are some of the reasons why investors may want to add commodities to their portfolio? A : There are several reasons why clients may want to invest in commodities. One is that commodities can be a nice way to diversify the portfolio as they have lower correlation to other asset classes. One of the biggest risks today facing the equities market is higher commodity prices. For example, high gasoline prices would act as a tax on the American consumer, this would be bad for many different types of stocks but would result in prices of gasoline going up, which would be captured positively in a commodity fund. The second reason is that commodities are one of the best performing asset class in periods of rising inflation. Commodities are real asset and can be used as a hedge against loss of purchasing parity. Finally, commodities are priced in dollars and the weakness in the U.S. dollar makes commodities less expensive for overseas buyers. To sum up, commodity investors tend to benefit from lower correlations to traditional assets, the ability to capitalize on increased demand from emerging markets and the ability to protect against rising inflation. Q:  What are the tenets of your investment philosophy? A : We focus on getting commodity-related returns for our clients. We use active management to improve return potential and decrease risk potential. For instance, we believe investors in the commodity market can win by not losing. In the last ten years we have seen prolific growth in the commodity market but investors would have lost a significant amount of appreciation in 2008, when commodity markets became overvalued and plummeted in the second half of the year. In our fund we have the ability to be tactical and reduce commodity exposure if we see negative price momentum similar to the second half of 2010. Q:  How would you describe your investment strategy? A : The fund invests in direct commodities, not in commodities-related stocks. There are three aspects to our approach. As mentioned above, the first one involves the tactical strategy, whereby we tactically reduce net commodity exposure when the technical trend appears negative. The second aspect is based on a relative value strategy, which enables us to actively overweight, underweight or even short individual commodities based on their relative attractiveness. The third aspect translates into a roll enhancement strategy that helps us, when one contract expires; seek to roll into the contract that may have the potential to optimize returns. That said, the most important part of these combined methodologies is to provide commodity exposure but to manage risk. Q:  Would you elaborate on correlation? A : We believe correlation is a cyclical event. It is true that in times of distress, most of the risk assets will trade in the same way but that is a somewhat unusual event. What generally happens is that once the market becomes more normalized, we see the correlation gradually decline and gravitate to more normal correlations. One of the reasons that having ability to overweight and underweight individual commodities can help performance is that individual commodities are driven by different factors. For example, more cyclical commodities like crude oil or copper may be driven by global GDP growth; while the price of corn or wheat may be driven by crop yields and specific weather events. Overall, in aggregate, the correlation of natural resource stocks compared to the S&P 500 index over the last ten years is about 0.75, whereas the correlation of direct commodities to the S&P 500 over the last ten years is about 0.33. So, we get a better diversification benefit by investing in direct commodities. Q:  How do you execute your portfolio construction? A : We start off with diversified exposure to the main commodity sub-sectors: energy, agricultural, base metals, precious metals and livestock, these sub-sectors include 19 individual commodities. The investment team uses a quantitative, rules-based methodology to determine the fund's commodity sector weightings relative to the fund's benchmark index, the Dow Jones UBS Commodity Index. The team underweights commodities that appear expensive and overweights commodities that appear cheap. Also, the team may reduce the fund's exposure to all commodity sectors when commodities in general appear overvalued. As mentioned before, we are focused entirely on direct commodities. We invest using commodity swaps or futures which are backed by conservative fixed income collateral. The relative value strategy seeks opportunities to capitalize on potential “mean reversion” in the prices of the six most actively-traded commodities in our universe - light crude oil, heating oil, gold, aluminum, corn and wheat. We use a disciplined quantitative strategy to analyze the long-term price of each commodity, namely its five-year average versus its short-term, one-year average price. We reweight the portfolio on a monthly basis. Q:  Do you have a view on the global macroeconomic scenario? A : Commodity prices inherently incorporate a lot of macro views in the marketplace. We use the technical indication of the price level as a way to reflect comparable opinions from a fundamental point of view to underweight or overweight a position. As we see some prices of the commodities to be overpriced or underpriced for that period of time, we use the price indicator as a proxy for that view. Q:  How do you manage risk? A : We manage our portfolio such that we seek to deliver a market performance plus commodity driven outperformance. We measure our risk taken against the benchmark and try to keep our positions within that risk limit. Additionally, we invest in commodity contracts with a range of maturities in attempt to mitigate commodity market volatility, avoid negative rolling and also minimize counterpart risk when we trade. Our multifaceted strategy provides investors with a diversified, active approach that focuses on risk management. Q:  What is your outlook for the commodity market? A : Our outlook for the commodity market is that we feel very constructive about commodities as a whole. Emerging markets have become a new growth engine globally, and China, especially, has been a huge consumer for many different commodities, everything from base metals like copper, aluminum to agricultural products like wheat, corn and even precious metal like gold from the retail as well as the government reserve perspective. We do see very strong positive effect of constructive factors coming from the emerging market. Most of the recent indicators in the U.S. have shown that there is slow but gradual economic growth which is a positive recovery for the marketplace. The Federal Reserve is very interested in keeping inflation under control and monetary policy accommodative so as to avoid any deflation scenario for the U.S. economy. We see that as a positive and constructive factor for commodities as a whole. If we look at the European economy as a whole, one third of the growth is from Germany and we anticipate the German economy to be strong going into 2011. We believe the sovereign crisis will be resolved without significant reverberations which could contribute to additional consumption of raw material and commodities, if Europe grows more strongly. In the short run, we see a lot of volatility, but in the medium-to-longer term we see very constructive factors for commodities as an asset class.

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The history of the fund actually starts before it was established. The team came together at the end of 2003. Using the same strategy we employ today, we primarily managed institutional international and global equity portfolios.

The history of the fund actually starts before it was established. The team came together at the end of 2003. Using the same strategy we employ today, we primarily managed institutional international and global equity portfolios.