Friday, March 17th, 2023
Better than equities, provided investors are selective
With equities looking overvalued and bonds still under pressure in the wake of a terrible year, investors are searching for new ways of generating attractive, risk-efficient returns. Commodities are one of the most widely-used alternative asset classes, but they have a reputation for high volatility, large drawdowns and periods of extended under-performance. At the index level, this is fair comment. Many investors are still scarred by their experience of boosting their exposure in the wake of the global financial crisis, only to exit at a lower level sometime in the next ten years. The key point to recognise is that some of the commodity contracts included in the overall index are unlikely to generate consistent returns over time. There are several possible reasons, which we discuss in the note, but the effect is that we have decided to exclude them from our Long Only model, in the same way that many global equity investors routinely avoid exposure to Japanese equities. Our Long Only model has no exposure to Livestock, Softs and most Grain contracts and focuses mainly on Energy, Industrial Metals and Precious Metals. On a standalone basis, it has produced total returns which are slightly better than US equities since inception in July 1997. If we allow the model to take short positions as well, we find that the returns are considerably better, with no loss of risk-efficiency and no significant increase in drawdown. The bottom line is that the right mix of commodities can produce attractive, risk-adjusted returns, provided investors are properly selective.