Historically, direct commodity investments have been a
minor part of investors’ asset allocation decision.
Commodity investments typically occurred through equity or
debt ownership of firms specializing in direct commodity
market production (e.g., Exxon Mobil for crude oil investments).
In recent years, however, investable commodity indices and
commodity-linked assets have garnered increased awareness
and interest. Recent academic studies have shown that indirect
commodity investment, through debt and equity instruments
in commodity-linked firms, does not provide direct exposure
to commodity price changes.3
Commodities are assets that
rise in price with inflation, providing a natural hedge against
periods of unexpected inflation. Anticipated inflation have at
times resulted in positive real returns for stocks and bonds through
high bond yields and high equity earnings growth. Unexpected inflation
on the other hand should cause concern to every serious
investor. Being exposed
directly to commodities offers the possibility of obtaining natural
commodity returns as well as inflation protection. Especially
in periods of unexpected inflation, market conditions may often
lead to increasing commodity prices and weakness in stocks and
bonds.
Correlation with Commodity Futures
Overlapping return data from July 1959 to March 20043
Notice that
Commodity Futures provide a natural protection against inflation
due to its positive long-term correlation. Consequentially, there
is a negative correlation with bonds and a nearly uncorrelated
and long-term negative correlation with stocks. Thus, adding
commodity futures to traditional investment portfolios provides
a hedge for inflation risks and stock/bond underperformance while
containing boosting overall potential for positive returns.
The following table is a portfolio analysis
comparing allocations across stocks, bonds, and commodity futures.
Notice that portfolios with traditional stock and bond allocations
are improved by investments into commodity futures. The highlighted
portfolios have maximized Sharpe Ratios (a measurement for risk-adjusted
returns), with at least a 10% allocation towards a commodities.6
Performance
of Portfolios including Commodity Indexes (1990-2004)
Portfolio I
S&P 500 & Lehman Bond
Portfolio II
S&P 500, Lehman Bond, & GSCI
Portfolio III
S&P 500, Lehman Bond, GSCI & HF Comp.
Portfolio IV
MSCI World & Lehman Global
Portfolio V
MSCI World, Lehman Global & GSCI
Portfolio VI
MSCI World, Lehman Global, GSCI & HF Comp.
Annualized Returns
9.64%
9.51%
9.99%
7.86%
8.07%
8.56%
Annualized Standard Deviation
7.94%
7.19%
6.87%
8.29%
7.55%
7.16%
Sharpe Ratio
0.67
0.73
0.83
0.43
0.50
0.60
Minimum Monthly Return
-6.25%
-6.18%
-6.28%
-5.61%
-5.67%
-5.77%
Correlation GSCI
(0.07)
0.47
0.22
(0.03)
0.48
0.24
GSCI: The Goldman Sachs Commodity
Index
Portfolio
I
S&P 500 & Lehman Bond
Portfolio
II
S&P 500, Lehman Bond, & S&PCI
Portfolio
III
S&P 500, Lehman Bond, S&PCI & HF Comp.
Portfolio
IV
MSCI World & Lehman Global
Portfolio
V
MSCI World, Lehman Global & S&PCI
Portfolio
VI
MSCI World, Lehman Global, S&PCI & HF Comp.
Annualized
Returns
9.64%
8.84%
9.64%
7.86%
7.42%
8.22%
Annualized
Standard Deviation
7.94%
6.93%
6.88%
8.29%
7.26%
7.15%
Sharpe Ratio
0.67
0.66
0.78
0.43
0.43
0.55
Minimum Monthly
Return
-6.25%
-6.28%
-6.33%
-5.61%
-5.76%
-5.82%
Correlation
GSCI
0.03
0.40
0.23
0.06
0.41
0.25
S&PCI: S&P
Commodity Index
Portfolio
I
S&P 500 & Lehman Bond
Portfolio
II
S&P 500, Lehman Bond, &
DJ-AIG CI
Portfolio
III
S&P 500, Lehman Bond,
DJ-AIG CI & HF Comp.
Portfolio
IV
MSCI World & Lehman Global
Portfolio
V
MSCI World, Lehman Global &
DJ-AIG CI
Portfolio
VI
MSCI World, Lehman Global,
DJ-AIG CI & HF Comp.
Annualized
Returns
9.64%
9.65%
10.26%
7.86%
8.47%
9.09%
Annualized
Standard Deviation
7.94%
6.76%
6.72%
8.29%
7.06%
6.89%
Sharpe Ratio
0.67
0.79
0.89
0.43
0.59
0.70
Minimum Monthly
Return
-6.25%
-6.27%
-6.33%
-5.61%
-5.76%
-5.82%
Correlation
GSCI
0.08
0.43
0.27
0.18
0.49
0.35
DJ-AIG
CI:The Dow Jones-AIG
Commodity Index
Portfolio
I
S&P 500 & Lehman Bond
Portfolio
II
S&P 500, Lehman Bond, & JCPI
Portfolio
III
S&P 500, Lehman Bond, JCPI & HF Comp.
Portfolio
IV
MSCI World & Lehman Global
Portfolio
V
MSCI World, Lehman Global & JCPI
Portfolio
VI
MSCI World, Lehman Global, JCPI & HF Comp.
Annualized
Returns
9.64%
10.51%
10.18%
7.86%
10.00%
8.22%
Annualized
Standard Deviation
7.94%
7.20%
6.93%
8.29%
7.39%
7.02%
Sharpe Ratio
0.67
0.86
0.85
0.43
0.77
0.77
Minimum Monthly
Return
-6.25%
-6.32%
-6.35%
-5.61%
-5.81%
-5.84%
Correlation
GSCI
0.10
0.51
0.33
0.17
0.56
0.39
JPCI: Jefferies
Commodity Performance Index
Portfolio I:
50% S&P 500 and 50%
Lehman Gov./Corp. Bond
Portfolio II:
40% S&P 500, 40% Lehman Gov./Corp.
Bond, and 20% Commodity Index
Portfolio III:
40% S&P 500, 40% Lehman Gov./Corp.
Bond, 10% Commodity Index, and 10% HF Composite Index
Portfolio IV:
50% MSCI World and 50% Lehman Global
Bond
Portfolio V:
40% MSCI World, 40% Lehman Global Bond,
and 20% Commodity Index
Portfolio VI:
40% MSCI World, 40% Lehman Global Bond,
10% Commodity Index, and 10% HF Composite Index
Risk Disclosure: There is a risk of loss in futures
and options trading. Past performance is not indicative of future results.
Nothing in this site is intended to be a recommendation to buy or sell
any futures or options market. All information has been obtained from sources,
which are believed to be reliable, but accuracy and thoroughness cannot
be guaranteed. Readers are solely responsible for how they use the information
and for their results.
Research Sources:
1.
Sesit, Michael R. ”Commodities
Enter Investment Mainstream: Pension Funds, Universities Jump Into
the Asset Class; High Returns, Low Risk”. 9 Sep 2004. Wall
Street Journal.
2.
Barclay Group, LTD. “Money Under Management
in Managed Futures”. 1 Mar 2006.
3.
Gorton, Gary (University of Pennsylvania) and
Rouwenhorst, K. Geert (Yale School of Management ). “Facts
and Fantasies About Commodity Futures”. June 14, 2004. Yale
ICF Working Paper No. 04-20.
4.
S&P Corp. and D.B. Stark & Company.
S&P 500 Index and Stark 300 Managed Futures Index Data. Dec 1981
to Dec 2005. Starkonline.com.
5.
Chicago Board of Trade (CBOT). “Managed
Futures Portfolio Diversification Opportunities”. 2005.
6.
The Center for International Securities and
Derivatives Markets (CISDM) of the University of Massachusetts Amherst. “The
Benefits of Managed Futures 2005 Update”. June 2005.
7.
Chicago Board of Trade (CBOT). “Trading
in Futures – An Introduction”. 2005.
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