Monday, 27 February 2017
Last updated 2 days ago
Oct 15 2012 | 8:02am ET
John Hummel may be bullish on gold but he's quick to point out he is not a gold bug. The founder, president and CIO of the Wilton, Conn.-based AIS Group has been managing portfolios—including endowments, foundations and the Federal Reserve retirement plan—for 40 years. AIS currently manages about $400 million across a multi-asset allocation program, a tactical asset allocation program, a capital growth strategy and a gold fund and is invested in gold through ETFs, futures and even bullion. Hummel shared his thoughts on gold (and other valuable commodities) during a recent conversation with FINalternatives Senior Reporter Mary Campbell.
Can you tell me something about AIS, particularly your futures strategy, MAAP?
Well, AIS first created a strategy called TAAP, which is a tactical asset allocation portfolio that uses stocks, bonds and cash equivalents but also includes gold. We brought gold in because of its negative correlation and the work that was being done with modern portfolio theory—when we saw the value of introducing gold into a portfolio of financial assets we said, 'Let's take this another step and let's look at other commodities.'
I'm a traditional portfolio manager by background and I used to manage a considerable number of large balanced portfolios. I had personally traded commodities for a number of years, which led us to use equity futures, bond futures and gold futures in the MAAP strategy. Initially we used crude oil futures and then soybean futures, and currencies, so we had six different markets. We could be long or short or we could be neutral. Then we expanded the portfolio in the commodities sector, so soybeans grew to grains, and crude oil included the entire energy complex and metals expanded to gold, silver and copper. We also now have multiple currencies.
Each of those six areas can only have up to one-sixth of whatever the maximum leverage is for the account. The maximum allocation to any of the markets helps us manage risk. We wouldn't get carried away and say, 'Well gee, we're really bullish on the energy market so let's really overweight that versus the other five.' We have two different levels of risk, one that can go up to four times leverage and one that can go up to six times.
Even six times leverage is relatively modest leverage when it comes to, for example, commodities, correct?
Absolutely. If you're trading currencies you can probably go up over 25 times leverage. Clearly the volatility of commodities, on average, is higher than it is in the financial instruments and that's the reason for limiting the leverage where we do.
You limit leverage and diversify investments. Do you do anything else to reduce risk when investing in commodities?
We're a discretionary manager but after 2008 we did introduce one systematic process to limit risk in the commodities sector. We've used a similar tool for years to monitor the stock market to determine its strength or weakness and in 2008 began applying the same process to the three commodities sectors. It indicates when we need to reduce leverage.
Is there any difference, other than leverage, between the four and six-times leveraged programs?
It's simply a function of the total contract size, whether long or short, relative to the amount of equity in the account. So a $1 million account at 6X leverage would have 50% larger positions than the one at 4X leverage.
I've read that you prefer investors willing to be invested long-term, up to 18 months? Why is that?
We do offer monthly liquidity and our individual accounts offer daily liquidity. That said, we are very long-term in our thinking and consider this one of our competitive advantages. Coming out of the traditional money management arena, we really think like a growth or value investor in terms of taking equity positions. But we're looking to take advantage of what we see as long-term trends—that's where we feel we have strength in thinking outside the box and identifying what's unique and different about a particular investment cycle that we're in.
You're bullish on gold right now, can we talk about that?
The first thing I always want to point out to people is that we are not gold bugs, we are what we consider to be pragmatic and opportunistic in terms of our investment decisions. As I mentioned, gold was originally brought in into our other traditional portfolio because of its negative correlation with financial assets. We were short gold in the middle to late 1990s for about two and a half years and it was a very profitable trade. In the MAAP futures strategy in the 1990s, basically the only positions that we ever had at any length were short positions.
Understanding whether it is a bullish or bearish environment for an asset is critical to being profitable. We found when we were doing our original research that looking at relative asset price performance was extremely important. When a particular asset begins to outperform other assets or underperform other assets it very often goes on for very long periods of time, for years, possibly even a decade or two. What initially turned us bullish on gold, roughly about 11 years ago, was the fact that after 21 years of negative performance both absolutely and on a relative basis, gold began to develop relative strength versus stocks and bonds. We said, 'Something significant is happening here,' and so we started to take advantage of it on the long side.
We use a lot of other things—we look at factors like the real cost of money, because if the real cost of money is extremely low, it's a very bullish environment for gold. We use technical indicators, both off-the-shelf and proprietary, that examine what gold is doing versus other currencies; what it's doing against other commodities, other metals; what it's doing against bonds as well as stocks. Things like this give us evidence as to its degree of strength or weakness. And frankly, what we've seen is that gold continues to be in a very orderly, long-term bull market—not only in absolute terms but in relative terms.
Our view is that although gold has gone up six or seven times from where it started, there's nothing about it that would suggest that we're seeing what we would describe as termination characteristics of a major bull market. Our other view is we think the dollar is in the sunset decade of being the world's reserve currency and neither we nor anybody else has any idea of what's going to take its place. But gold is becoming more important again to central banks and we think it has a lot further to go.
As an investor in commodities programs, how does something like this past summer's drought affect you?
First off, we've been bullish on grain markets primarily from a demand standpoint—the developing world is the engine of growth and the expansion of the middle class in the developing world is a phenomenon that's unique in the world. What tends to happen is that people whose incomes rise tend to take on spending characteristics we've experienced here in the Western world, and so there's much greater meat consumption. It takes anywhere from two to seven times as much grain to produce a pound of meat versus when people eat the grain directly, so you've got an expanding group of people who are moving to meat proteins and that's almost a geometric expansion of demand on grain as a result. Grain inventories have been getting extremely low, even before the drought of this year. So the drought’s occurrence is one of those additional surprises that very often happen to markets in major trends that accelerate those trends, it's just setting up very difficult times going forward. It's difficult for me to talk about the grains from a profit standpoint because there's also human beings out there that are negatively affected both in terms of rising food costs and it's hurting farmers that don't have irrigation, but the fact of the matter is it's just exacerbating the tightness in the bull market.
Do you think managed futures can provide protection against tail risk events?
I guess the bottom line is if you're on the right side of a particular market it will give you protection in tail risk. We were short the equity market from 2007 on and called that very accurately. Because we were as bullish on a long-term basis on commodities and thought they were still in a very infant stage of their bull market, we didn't do as good a job of being short commodities as other firms did. But we’ve turned it around and have run circles around most of the managed futures managers since then.
In terms of tail risk, I think that tail risk occurs more often when it's something that people are totally unprepared for. Today’s environment is one of domination, I think, by the emotion of fear rather than greed. People are expecting the unexpected. The things that have been going on in Europe, for instance, in the last two years, are well publicized. We know what the problems are. Contrarian that I am, I think some of the events people are so worried about are less likely to happen, simply because of the fact that they're known and they're out there. I think a bigger tail risk is something I mentioned earlier—does the dollar remain the world's reserve currency and what kind of turmoil could happen there? It's one of the reasons why I think that gold could be a significant portfolio protector against whatever problems might occur simply because it's so under-owned at this point.
How does AIS invest in gold?
We have three strategies that have participation in gold. Within the MAAP futures program, we only use futures and so we're trading gold futures on the COMEX, silver futures, copper futures. In our tactical allocation portfolio, our original portfolio, we buy gold bullion. For larger accounts, we're buying gold bullion—400 ounce bars in Zurich—and having them stored and fully allocated. For smaller accounts, we're using ETFs now. In our gold fund, we invest in both gold futures and mining companies with a heavy emphasis on juniors but the futures program is gold futures only.
What is the advantage to a discretionary rather than a systematic approach to managed futures?
We started out as a systematic manager but observed a few things after about the first decade that influenced our move to discretionary management. It seemed like there was too big a crowd on the systematic side who were all moving about the same time (when systematic signals occurred, the move had pretty much run its course). We also felt that our profits were being made with the major trend, not with the countertrends. We felt that we had always spent a lot of time thinking about the global macro environment and knew we had a reasonably good handle on that and could bring an advantage to the table. We see advantages to being discretionary while incorporating systematic risk management.