Commodity futures in your investment portfolio – Is there really any future for individual investors?
The Skilled Investor’s previous article, “Be wary of the new investment asset classes,” voiced skepticism about many supposedly new asset classes. This article delves into the financial science behind this skepticism, as it relates to one of these supposedly new asset classes. In this article, we focus on whether commodity futures really are a good candidate for long-term holdings in the portfolios of individual investors.
Particularly since the dot com crash, there has been a lot of talk about commodity futures as an appropriate asset class for individual investors to hold in their investment portfolios for the long-term.
It seems that returns from the traditional stock-equity asset class just have not met some investors (perhaps unreasonably inflated) return expectations. It also seems that the securities industry is always willing and eager to offer supposed help to those investors who want higher returns. However, is the industry doing individual investors any favors by promoting commodity futures as an asset class for individual investors’ portfolios?
To look more closely at the newly touted commodity futures asset class, you could read “The Tactical and Strategic Value of Commodity Futures” by Claude B. Erb of the Trust Company of the West and by Campbell R. Harvey of Duke University (January 12, 2006). In this study, Erb and Harvey dissect the sources of commodity futures returns and analyze investment strategies that might make appropriate use of commodity futures. They conclude that commodity futures can play a role in tactical investment price insurance strategies, when conducted by very sophisticated traders and investors. This is the role that commodity futures have filled for well over a hundred years. Erb and Harvey state in their conclusion that “the goal of this paper is to explore both the strategic and tactical opportunities that these assets present to investors.” (page 55)
A key question is whether commodity futures tend to provide a “risk premium” for a long term passive buy-and-hold strategy, just as equities have exhibited.
Is it appropriate to re-purpose commodity futures and make them a new asset class within the long-term portfolios of individual investors? In the past few decades, commodity futures have increasingly been used by sophisticated institutional money managers, such as university endowment investment managers, in an attempt to increase overall risk-adjusted portfolio returns. Some professional managers have been quite successful [...]