Research and Insights Library

An Asset Class for All Seasons: The Benefits of a Strategic Allocation to Commodities

Abstract:

Commodity futures are a unique and investable asset class that provides valuable diversification benefits in a traditional balanced (stock/bond) portfolio. At Gerstein Fisher, we believe that a number of forces speak for the inclusion of a strategic allocation to commodity futures.

While commodities have been in the media spotlight recently, they always have been on our radar screen at Gerstein Fisher. Because commodity prices historically have demonstrated an inverse relationship with the direction of financial assets like stocks and bonds, they offer compelling diversification benefits to a portfolio composed mostly of stocks and bonds.

An Inverse Relationship
When contemplating the addition of a new asset class to a portfolio, a key consideration is how that asset class interacts with the rest of the portfolio. Ideally, we want to add assets that behave differently from the existing portfolio elements, as such low-correlating assets enhance diversification and can reduce overall portfolio risk.

Using 45 years of monthly return data from a Yale University study [“Facts and Fantasies About Commodity Futures,” Gary Gorton and K. Geert Rouwenhorst, June 14, 2004] we analyzed the performance of commodity futures during periods when stocks and bonds performed particularly poorly. The results supported the commonly held view that commodities provide valuable diversification benefits, i.e., have zero or negative correlation to stocks and bonds. For example during the months when a balanced portfolio (60% stocks/40% bonds) posted negative returns, commodity futures on average posted strong (double-digit) positive returns. The same relationship holds true when looking at stock and bond returns separately versus commodities: historically, commodity futures’ best returns generally occur when stock and/or bond returns are negative. We expect this relationship to hold going forward.

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