EmptorMaven

Last year I recommended TIPS funds as particularly attractive for tax-exempt investment accounts.

TIPS have gained substantially since then, but from a historical perspective the current 10-year TIPS break-even rate of 2.1% is still low. (“Break-even” is the realized inflation rate above which an inflation-protected security will pay more than its non-inflation-protected equivalent. In the case of TIPS that would be regular treasury bonds. A break-even rate of 2.1% means that ). Since inflation protection is valuable insurance in a market like this, with low current inflation but exploding money supply (which could easily lead to surprisingly high inflation in the next few years), one might expect TIPS break-even rates to run above the long-run expected inflation rate, which is around 2% per year. Indeed, it is still cheaper to buy TIPS than to buy treasuries and hedge against inflation with options.

However, as I noted earlier, TIPS aren’t a perfect inflation hedge. Bill Tedford, a successful treasury bond portfolio manager and inflation bug, has other ideas on investing for protection against inflation:

In his own portfolio, Mr. Tedford has begun shorting 30-year Treasurys, expecting the prices to fall as interest rates begin to rise. For clients, however, Stephens is encouraging the use of exchange-traded funds to own exposure to real assets. Mr. Tedford says a 5% or 10% position overall “is big enough to protect a larger portfolio.”

Among ETFs, Stephens likes the U.S. Gasoline Fund, the iShares Dow Jones U.S. Oil & Gas Exploration & Production Index, SPDR Gold Trust, PowerShares DB Base Metals Fund and the PowerShares DB Agriculture Fund. The firm also likes Plum Creek Timber Co.

Though Treasury inflation-protected securities, or TIPS bonds, would seem a natural bet, Mr. Tedford says his group just this month sold off its TIPS investments. Real yields on TIPS are barely above 1% now and Mr. Tedford expects those yields will increase as inflation mounts, hurting prices, which move in the opposite direction.

The likely result: “The return on your TIPS could fall 10% or 15%,” basically wiping out the bond’s inflation protection.

I would personally steer clear of gold as an inflation hedge because it is particularly prone to speculative bubbles, and has less intrinsic value than most other commodities. But diversified investments in energy, industrial metals, and the agricultural sector should also serve as good long-term inflation hedges.

I suppose you can’t fault Wall Street for catering to demand, but as I explained a few years ago hedge fund clones are ridiculous investments. Nevertheless, the WSJ reports investors are still lining up for these offerings and banks are still rolling out new ones.

While most clones have so far generally kept pace with broad hedge-fund indexes, their performance has been all over the map. Between March 2008 and Sept. 30 of this year, clones studied by researchers at Haute Ecole de Gestion in Geneva and Bank Julius Baer & Co. delivered annualized returns ranging from -21% to 6%. And some clones this year have sharply underperformed broad hedge indexes. State Street’s Premia Fund was up less than 2% in the first 10 months of this year, compared with a 10% gain for the HFRI Fund of Funds Composite Index.

Even Andrew Lo, one of the originators of the “clone” concept, and current manager of a replication fund, has to admit that this concept is missing a big piece of the game:

Being restricted to easily traded holdings, replicators may not capture a big chunk of hedge-fund performance. Anywhere from 10% to 60% of hedge-fund returns may come from a premium earned by holding illiquid assets….

I recently reviewed the new U.S. version of the Steyr AUG/A3.  At the time I noted that Microtech Small Arms Research (MSAR), which has spent several years rolling out its “STG-556″ AUG clone, would probably retain a pricing and innovation edge over Steyr.  During the recession MSAR cut its wholesale price from above $1400 to $1050.  Then, in just the last few weeks, MSAR dumped their entire inventory on distributors at even lower rates, allegedly because they are moving their operations from Bedford, Pennsylvania to Raleigh, North Carolina.

Since I was already thinking about getting another receiver or barrel, I couldn’t pass up an opportunity to get an entire bullpup carbine for under $1100.  Following are observations on the fourth-generation STG-556 I purchased, shown here below my Steyr AUG/A3 USA.

I was struck by a number of small but clever improvements MSAR has made to the AUG design:

• The MSAR 16″ barrel uses 1:8 rifling, which is sufficient to stabilize up to 77gr bullets.  (The AUG only comes with 1:9 twist, which is marginal for bullets over 70gr.)
• The MSAR is more than half a pound lighter than the AUG/A3.
• The MSAR has quick-detach sling loops on both the receiver and the stock pin.  (In contrast, the AUG’s front sling loop is held in by a coil pin so it cannot be easily removed when not in use.  Its rear loop can be switched from side to side by removing the entire stock pin, but cannot be completely removed.)
• The MSAR stock has two QD sling loop attachment points molded into the stock, underneath the pistol grip and under the toe.
• The MSAR trigger pack actually locks into the stock.  You have to press the bolt catch to release it.  (The AUG’s trigger pack just falls out.)

The MSAR beats the Steyr not only on price but also with these design enhancements.  The only two things the AUG has going for it are (1) the support and reputation of Steyr-Mannlicher, and (2) the fact that it has met the production and performance standards of many professional militaries for many decades.

Other observations:

• A new MSAR is tighter than a new AUG in a several dimensions: You actually need the help of the recoil spring to get the receiver to pop out of the stock during disassembly.  And magazines do not drop free when released unless nearly fully loaded.
• The MSAR bolt locks open on an empty magazine, after which it can only be closed using the bolt catch just above the magazine release.  In contrast, the AUG bolt can also be released using the slide-cocking handle.
• The Gen-4 MSAR has no forward assist.  The AUG’s slide-cocking handle can be used as a forward assist.
• Sadly, like the AUG, the standard STG-556 barrels use metric muzzle threads, so you’ll have to buy an adapter to use your American suppressors.

Important notes when purchasing an STG:

1. MSAR’s fourth generation starts with serial number 6500.  MSAR has manufactured at least five thousand Gen4 STG-556 guns.
2. Earlier STG-556 versions have a Stoner-style Forward Assist (“FA”) and some compatibility problems.  Therefore I would avoid serial numbers lower than 6500.
3. Don’t confuse the STG-556 with MSAR’s STG-E4.  The E4 is a Gen4 variant compatible with AR-15 magazines — quite like the Steyr NATO conversion I described previously.  It comes with many more rail mounting positions and runs at least another $250.
4. The Gen4 STG-556 works with AUG magazines.  (It also appears to work with Steyr’s NATO conversion kit, although I only confirmed that its receiver fits in mine; I haven’t test fired it.)
5. It ships from the factory with 5 MSAR magazines.
6. MSAR STG-556 magazines do not work with AUGs without some extra machining.