The Passive Approach to Commodity Investing

Plante, Jean-François; Roberge, Mathieu
May 2007
Journal of Financial Planning;May2007, Vol. 20 Issue 5, p66
Academic Journal
• Investing in commodities is one potential avenue to improve the risk/return profile of a portfolio in the current environment of low bond yield and low equity-risk premium. The emergence of commodity exchange-traded funds has facilitated access to commodity markets while preserving the most advantageous features of passive commodity investing. • Commodity trading is conducted with futures contracts and results from the interaction between hedgers and speculators, which creates the dynamism of the commodity market. Some sophisticated investors take an active approach by investing in specific commodities. But most investors will opt for a passive approach through ETFs and mutual funds that follow one of the commodity indexes such as the Goldman Sachs Commodity Index or the Dow Jones AIG Commodity Index. • It is argued that investing through these passive vehicles allows, investors to enjoy roughly the same benefits they would have derived from diversified, fully collateralized positions in the individual commodities futures. The advantages of integrating a passive commodity investment in a portfolio include better diversification, better protection from inflation (especially unexpected inflation), and an interesting expected return. The article shows the risk-reduction benefits from introducing commodities into a traditional 60/40 stock/bond portfolio. • It is reasonable to assume that the expected return over time of the spot price of a given commodity is close to zero. Despite that, passive commodity investing can earn positive returns due to an implicit "insurance premium" in the futures contract, to index rebalancing, and to the return of the T-bills used to fully collateralize the positions in futures. • A study examines and verifies that these sources of returns materialized into actual returns from 1970 to 2006.


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