Is Now the Time to Add Commodities?
Excerpted from the Fall 2010 issue of The Journal of Investing.
With the recent increase in equity volatility, commodity investments have garnered significant attention from investors. Previous research has found substantial benefits associated with commodity investments, but there remains considerable uncertainty regarding the consistency and general applicability of those benefits for equity investors.
We provide evidence that helps to resolve some of the uncertainty with regard to commodity investments. Specifically, based on a sample period of 36 years, we show substantial benefits to commodity investments regardless of the equity style an investor pursues. To obtain a significant benefit, however, requires a commodity allocation of greater than 5%. Interestingly, adding a commodity exposure enhances an equity portfolio’s return only during periods when the Federal Reserve is increasing interest rates, which is consistent with the belief that a major attraction of commodities is that they serve as an inflation hedge. Furthermore, an allocation to commodities in a tactical asset allocation using monetary conditions consistently outperforms both a strategic commodities allocation and an all-equity portfolio.
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Mitchell Conover , Ph.D., CFA, is an associate professor of finance at the Robins School of Business, University of Richmond.
Robert R. Johnson , Ph.D., CFA, is the senior managing director at the CFA Institute.
Gerald R. Jensen , Ph.D., CFA, is a professor of finance at Northern Illinois University.