Significant Benefits to Investors Who Invest in Precious Metals

New Study Finds Significant Benefits to Investors Who Invest in Precious Metals



Study tracks the long-term benefits of several strategies that add precious metals to investment portfolios; four major findings are reported.



Charlottesville, Va., March 3, 2008 − The co-authors of several acclaimed research papers that examine the merits of alternative investment strategies today released a study that presents new evidence on the benefits of adding precious metals to U.S. equity portfolios.

The study, “Can Precious Metals Make Your Portfolio Shine?,” extends the results of earlier studies on the benefits of investing in gold, silver, and platinum. The authors address two major investor concerns: What are the benefits of investing in precious metals and how can investors achieve a beneficial exposure to precious metals? Their findings suggest that precious metals serve as an effective hedge against the typical decline in equities that occurs during an increasing interest rate environment. And, to best capture these benefits, investors should allocate a prominent percentage of their portfolio to the equities of precious metals firms.

The co-authors of this study are Robert Johnson, Ph.D., CFA., deputy CEO of CFA Institute and managing director of the CFA Institute Education department; C. Mitchell Conover, Ph.D., CFA, associate professor of finance at the University of Richmond School of Business; Gerald R. Jensen, Ph.D., CFA, professor of finance at Northern Illinois University College of Business; and Jeffrey M. Mercer, Ph.D., associate professor at the Texas Tech University College of Business. (Their other relevant studies are “New Study Suggests Investors Should Consider Fed Policy in Trading Decisions” and “Gridlock's Gone, Now What?”)

“Recession fears in the U.S. have been driving up precious metals prices to historically high levels,” said Johnson. “Our study examines the long-term investment benefits of a significant exposure to precious metals and shows that those benefits are concentrated during periods of Federal Reserve tightening.”

The main findings from the 34-year study period are:

1) For a U.S. equity investor, portfolio performance improves substantially when a prominent portion of the portfolio is re-allocated to the equities of precious metals firms. Allocating 25 percent of the portfolio to precious metals equities increases annual returns by 1.65 percent and reduces the portfolio’s standard deviation by 1.86 percent. Smaller allocations to precious metals improve portfolio performance, but to a lesser degree.

2) The investment benefits are considerably larger if the exposure to precious metals is obtained indirectly via an investment in the equities of precious metals firms, rather than directly by purchasing the precious metal as a commodity (e.g. gold bullion).

3) During periods of Federal Reserve tightening (when interest rates increase), the returns to precious metals commodities are significantly higher than they are during expansive policy periods (when interest rates decrease). This result is in stark contrast to the U.S. equity market and the equities of precious metals companies.

4) Both direct and indirect investments in precious metals provide significant return and risk benefits to U.S. equity portfolios during periods of Fed tightening, which represent 45 percent of the sample period. In contrast, neither direct, nor indirect investments in precious metals provide benefits of much consequence when the Fed is easing.

“Like other studies, we show evidence that adding a precious metals exposure to an equity portfolio improves performance significantly,” said Jensen. “Our main contribution, however, is to show investors that making a prominent allocation to the equities of precious metals firms provides the best means of capitalizing on a precious metals exposure.”

The study examined daily returns for the U.S. equity market and six alternative precious metals indices from January 17, 1973 through December 2006. Two indices represent indirect investments in precious metals (purchasing the equity of precious metals firms), and the other four indices represent direct investments in the metals (purchasing the commodities).

On February 1, 2008, the New York spot price of gold was $907.90 per troy ounce, down from a record $933.10 and the price of platinum was $1756.00 per troy ounce.

CFA Institute
CFA Institute is the global membership association that administers the Chartered Financial Analyst® (CFA®) and Certificate in Investment Performance Measurement (CIPM) curriculum and exam programs worldwide; publishes research; conducts professional development programs; and sets voluntary, ethics-based professional and performance-reporting standards for the investment industry. CFA Institute has more than 93,000 members, who include the world’s 80,000 CFA charterholders, in 131 countries and territories, as well as 135 affiliated professional societies in 56 countries and territories. More information may be found at www.cfainstitute.org. (Bloomberg users can find CFA Institute at 497458Z).

Noisy Market Hypothesis Jeremy Siegel

This new paradigm claims that the prices of securities are not always the best estimate of the true underlying value of the firm. It argues that prices can be influenced by speculators and momentum traders, as well as by insiders and institutions that often buy and sell stocks for reasons unrelated to fundamental value, such as for diversification, liquidity and taxes. In other words, prices of securities are subject to temporary shocks that I call "noise" that obscures their true value. These temporary shocks may last for days or for years, and their unpredictability makes it difficult to design a trading strategy that consistently produces superior returns. To distinguish this paradigm from the reigning efficient market hypothesis, I call it the "noisy market hypothesis."
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The noisy market hypothesis easily explains the size and value anomalies. If a stock price falls for reasons unrelated to the changes in the fundamental value, then it is likely -- but not certain -- that overweighting such a stock will yield better than normal returns. On the other hand, stocks that rise in price more than their fundamentals become "large stocks" with high P/E ratios that are likely to underperform.
These discrepancies are not easy to arbitrage away on a stock-by-stock basis. The noisy market hypothesis does not say that every stock that changes price does so by more than what is justified by fundamentals. Any particular stock may still be undervalued when it moves up in price or overvalued when it moves down.

Source:
The `Noisy Market' Hypothesis By Jeremy J. Siegel, Wall Street Journal, 14 June 2006

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Mixed-Gender Fund Management Teams

Mint reported this research in page 13 of 15th October 2007

In the paper titled "The Impact of Work Group Diversity on Performance: Large Sample Evidence from the Mutual Fund Industry" authors Stefan Ruenzi, Michaela Baer, and Alexandra Niessen came to the conclusion that mixed gender fund management teams are underperforming single fund managers, and single gender fund management teams. The study covered the period from January 1996 to the end of 2003 and average of 300 funds per year.

The think the relative poor performance can be traced in large part to the poorer communication that often exists in mixed teams.

The Mint's reporter discussed the research results with woman fund managers of india Swatim Kulkarni and Gautami Desai of UTI MF and Jyoti Vaswani of Aviva Life Insurance. They are not agreeing to the views expressed in the study

Objective of Blog

To record the summaries of research papers and projects in the area of Security Analysis and Portfolio Management and to examine their relevance for immediate practice.