The two primary indices for commodity investing have been the S&P GSCI and the Bloomberg indices. These indices are dramatically different in terms of weighting structure with the S&P GSCI being very energy heavy (63% weight) while the Bloomberg index tends to be more balanced across the primary commodity sectors. As a consequence both indices can have significant performance differences.
Both indices aim to cover the broad spectrum of most actively traded commodities. Commodity pricing is primarily determined by global supply and demand conditions, but that is where the similarities among commodity sub-groups often end.
When investors think of constructing their portfolios usually the starting point are broad asset classes such as stocks and bonds. Asset classes tend to possess fairly well defined risk and return characteristics and represent aggregations of “similar” investment types.
As an example, stocks are usually broken down into economic sectors but most investors would agree that stocks are driven to a large extent by what happens to the broad equity market. Similarly, while fixed income investments are frequently broken down by maturity and credit worthiness, the key driver of fixed income returns tends to be the general direction of government bond rates. In general, return correlations within asset classes such as stocks and bonds tend to be high and frequently exceed 0.8.
When evaluating investment returns within the commodity complex the high within asset class correlations typically seen among stock and bond investments are absent. More common are correlations in the 0.2 to 0.4 range.
The low correlation among commodity groups is a manifestation of a less homogeneous asset grouping than typically seen for other broad asset classes such as equities and bonds. Given that each commodity group has its own supply and demand dynamics and the vastly different swing pricing factors this result is to be expected.
Thinking of commodity investing as a broad concept has been useful for investors as a way to get their feet wet, but given the current depth of commodity markets, the variety of liquid investment vehicles available, and most importantly the dissimilar behavior within the commodity complex we think that looking at the space as one homogeneous asset class is like comparing apples to oranges.
Other sections in this report include:
- Thinking of commodity return behavior in terms of risk exposures
- What do the risk estimation exposures tell us about commodity sub-group behavior?
- What does our research imply for commodities in the context of a multi-asset portfolio?
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Eric J. Weigel
Managing Partner, Global Focus Capital LLC
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