Organization NewsAre you...New Study Shows that Investors May Now Want to Consider Adding Commodities to Their Portfolios 

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The authors, Mitchell Conover, CFA, Gerald Jensen, CFA, Robert Johnson, CFA, and Jeffrey Mercer, apply a straightforward tactical asset allocation strategy based on Federal Reserve policy to examine portfolio returns over the past 36 years. They find that allocating a portion of a portfolio to commodities produced significant improvements in portfolio risk and return; however, the improved performance varied significantly across monetary environments.

The authors use changes in Federal Reserve policy rates to identify changes in monetary conditions. In particular, an increase in policy rates is used as an indicator of a shift to a restrictive monetary environment, while a rate decrease identifies a shift to an expansive monetary environment. Supplementing a portfolio with commodity futures substantially reduces portfolio risk in both restrictive and expansive monetary environments. The effect of commodities on portfolio returns, however, varies substantially over the different monetary environments. When the monetary environment is expansive, a 15 percent allocation to commodities reduces portfolio returns by up to 2.4 percent a year. On the other hand, adding commodities to an equity portfolio during restrictive monetary environments increases returns by as much as 2.4 percent annually.

The results confirm the long-held market view: When inflation is a concern (which is likely when the Federal Reserve is increasing interest rates), commodities provide a substantial return benefit to equity portfolios. The surprising result from this study is that, remarkably, the timing of the allocation to commodities can be guided by a well-known and easily observable signal of Fed intentions, the Fed discount rate. Given current inflationary concerns and the fact that the Fed recently raised interest rates, the study’s results suggest that an allocation to commodity futures may be appropriate.  

The authors consider a tactical asset allocation strategy, which commits a portion of an equity portfolio to commodities when monetary conditions are restrictive, but adds no exposure when monetary conditions are expansive. The tactical strategy's performance is compared to an all-equity portfolio and a strategic asset allocation strategy where the investment in commodities is constant at 15 percent throughout the entire time period. The tactical asset allocation strategy consistently outperforms the other two strategies over the 36-year period.

Lastly, the authors find that an investment in commodities benefits both conservative and aggressive equity investment strategies. Specifically, they find that investors following value, growth, small-cap, large-cap, and momentum strategies all lower portfolio risk by adding an allocation to commodities. Surprisingly, however, the risk reduction benefit is significant only when the allocation to commodities is greater than five percent.

About CFA Institute

CFA Institute is the global association for investment professionals. It administers the CFA and 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 nearly 100,000 members, who include the world’s 87,700 CFA charterholders, in 131 countries and territories, as well as 137 affiliated professional societies in 58 countries and territories. More information may be found atwww.cfainstitute.org.

News Source : Organization NewsAre you...New Study Shows that Investors May Now Want to Consider Adding Commodities to Their Portfolios