Taking REIT and commodities away from equity allocation?

In Diehards Conversations #52817, reply 10, Larry Swedroe mentioned taking REIT and commodities away from equity allocation because they are separate asset class. My target portfolio has 10% REIT and 5% commodities within the equity allocation, as shown in (A):

25% fixed income
75% equity
|—— 85% equity
|—— 10% REIT
|—— 05% commodities

If I take out REIT and commodities to form separate asset class, it will look like (B). The 21% fixed income vs 64% equity in (B) still maintain the target of 25% fixed income vs 75% equity ratio in (A).

21% fixed income
64% equity
10% REIT
05% commodities

If I calculate the bond:equity ratio in (A) according to the way in (B), the ratio is 28:72 [72 = (75*0.85)/(75*0.85+25)]. This is not much different from the original 25:75 ratio in (A). I just need to be aware of the higher fixed income allocation when doing rebalancing. I think I will stick to (A) and save my time in updating my spreadsheet, again.


7 responses to “Taking REIT and commodities away from equity allocation?

  1. How do you intend to get the commodities exposure? Was it through stock equity using a resource ETF or through CCF (collaterized commodity futures)? You must have mentioned this before but I can’t remember.

  2. I intend to use CCF (collaterized commodity futures). Currently CCF ETFs (like DBC or GSC) have high distribution that is subjected to withholdng tax, so I am considering the new CCF ETNs (exchange traded note) from iShares like DJP. CCF ETNs do not intend to make distribution hence more tax efficient.

    I have planned to write something about CCF ETN but just caught up with other things. Anyway, I am not adding CCF so soon, not until my portfolio has grown to a bigger size. This also allows me to see how well ETN will turn out to be.

  3. The tax status of DJP is still uncertain — the IRS could rule to the detriment of the fund. Of course the other issue is you need to add the credit risk of Barclays (rated AA I think) into the mix. I guess it is good to watch for a while before jumping in. Of course

  4. Regarding the question in your original post, if you decide that you need a safety anchor of 25% in bonds, I would not consider REIT or CCF as part of the safety anchor and reduce the bonds to 21%.

    Maybe it is true that CCF has shown itself to be a good insurance in the recent equity downturn, but I don’t think it is ever a perfect substitute to treasury-grade bonds. In a very severe depression / deflation, when commodities prices are dropping, I don’t think CCF would ever serve as part of the safety anchor. Furthermore, CCF and REIT are both as volatile as equity.

    I think if you originally have

    25% bonds / 75% equity

    and you want to have 5% CCF and 10% REIT, your portfolio should now look like

    25% bonds / 60% stock equity / 10% REIT / 5% CCF

    Continue to keep the bonds at 25% of the total.

    PS. For my portfolio, I have lumped my REITs/REOCs exposure into equity; and I don’t use CCF.

  5. Since the difference is small between (A) and (B), I am sticking to my original 25% bonds allocation (better safe than sorry) and squeeze REIT and CCF into equity allocation, as per the original allocation in (A). Because I squeeze REIT and CCF into equity allocation, the portfolio looks like this:

    25% bonds / 63.75% stock equity / 7.50% REIT / 3.75% CCF

    CCF…. still “wait and see”…

  6. I think that the target % for asset classes should reflect some assessment of the future for the class. For example, now that the S&P p/e is down around 14 -15, I would increase that segment, whereas bond tip spreads are somewhat lower than usual, so I would decrease the bond segment. Gibson’s book makes a strong case for more REIT (I assume commercial) than the 10% or so that is often suggested, and with REIT dividend yields around 7-8%, I would increase REITs %.

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