In the academic paper, Facts and Fantasies about Commodities Futures, Yale professors Gary Gorton and K Geert Rouwenhorst construct an equally weighted index of commodity futures monthly returns between July 1959 and December 2004, in order to study the properties of commodity futures as an asset class.
They concluded that while the risk premium on commodity futures is essentially the same as equities, commodity futures returns are negatively correlated with both equity and bond returns. The negative correlation between commodity futures and the other asset classes is due, in significant part, to different behaviour over the business cycle.
In recent months, the rise of alternative ETFs based on commodity indices has sought to capture the long-term diversification and low correlation with traditional assets that the Yale academics uncovered in their study. “The focus on commodity ETFs has intensified as long-term investors like pension funds are realising the benefits of having exposure to assets with either a low or negative correlation to equities and bonds,” says Dan Draper, global head of Lyxor ETFs.
The recent sell-off in equities has underlined why some exposure to an ETF that replicates the movement of a commodities index makes sense in periods of financial market distress, experts say.
Mr Draper points to a 40 per cent out-performance of equities by commodities in the first six months of 2008 as strengthening the case for investing in ETFs linked to physical assets like copper or corn.
“We tell our clients that investing in commodities is not only a low or negative correlation story, but also a store of value in times of severe financial stress – such as today. It’s about having real assets in your portfolio, not just paper financial assets,” he says.
And Lyxor’s two flagship commodity ETFs – CRB energy and CRB non-energy – are among the best performers from the asset manager’s 125 ETFs on offer. The commodities CRB energy ETF – linked to the Reuters/Jefferies CRB index of commodities like crude oil, gold, sugar and orange juice futures contracts – has returned 15 per cent year to date.
The CRB non-energy ETF has returned about 9 per cent in the last six months of trading, with a spread of 15 commodities in the portfolio, minus crude oil but inclusive of commodities such as soya beans, live cattle and nickel.
“Our commodities CRB non-energy ETF has a diversified portfolio, providing investors with exposure to an index of evenly-weighted, less volatile, commodities without necessarily relying on the performance of oil for returns,” says Mr Draper.
In addition to ETFs tracking indices based on a commodities basket, investors can also access ETFs based on physical assets – and therefore any rise in value. For example, the price of copper has rocketed this year, largely because of demand increases in China and speculative buying by hedge funds. Investors receive a return equivalent to movements in the metal’s spot price, less fees.
“The price of a physical commodity will go up, and down, but will always retain some intrinsic value,” adds Mr Draper.
But volatility notwithstanding – prices of precious metals have shown wide short-term swings in the last 12 months, but an upward trend over the medium-term – investors are warming to the diversification that allocation to commodities can provide. “Investors get a nice risk return profile and the advantages of a diversified portfolio. Most notably pension funds have begun allocating to commodities through the diversification message,” adds Mr Draper.
RESEARCHED AND PUBLISHED IN ASSOCIATION WITH LYXOR ASSET MANAGEMENT.
