Commodities have become an important tool in portfolio management strategies due to their good performance, the bullish outlook for this asset class over the next decade with commodity prices setting new highs and in contrast, the highly volatile performance of stocks and bonds as well as the major equity crashes in recent years.
This book analyses why and which commodities should be added to your portfolio. It gives a thorough introduction and analyses:
• Basic concepts of portfolio management and commodities
• Different investment exposures to commodities
• Return decomposition of commodity futures
• Evidence that commodities constitute an asset class
• Comparison of the different asset classes regarding risk, return and correlation as well as the performance analysis of the single asset classes with regard to the business cycle and inflation
• Efficient frontiers of portfolios with and without commodities over different periods of time
The key objective of this study is to investigate how commodities as an asset class influence the risk-return-ratio of a traditional portfolio in a passive investment strategy over various periods of time.
Table of Contents
1 Introduction
1.1 Problem Definition and Ambition
1.2 Research Methodology
2 Portfolio Management
2.1 Basics of Portfolio Management
2.1.1 Risk
2.1.2 Return
2.2 Modern Portfolio Theory
2.2.1 Idea and Assumptions of Markowitz’s Portfolio Selection Model
2.2.2 Statistical Basics
2.2.3 Efficient Frontier
2.3 Capital Market Theory
2.3.1 Capital Asset Pricing Model
2.3.1 Capital Market Line and Market Portfolio
2.3.2 Security Market Line
2.4 Criticism
3 Commodities
3.1 Commodities Definition
3.1.1 Commodity Classes
3.1.1.1 Energy
3.1.1.2 Precious Metals
3.1.1.3 Industrial Metals
3.1.1.4 Agriculture
3.1.2 Economics of Commodity Markets
3.1.2.1 Commodity Futures Exchanges
3.1.2.2 Driving Forces behind the Current Commodity Bull Market
3.1.2.3 Market Participants
3.1.3 Exposure to Commodities
3.1.3.1 Futures
3.1.3.2 Index Investments
3.1.3.3 Stocks
3.1.3.4 Funds
3.1.3.5 Physical Commodities
3.2 Criticism
4 Investing in Commodity Futures Indices
4.1 Mechanics of an Investment in Commodity Futures
4.1.1 Relationship between Futures Prices and Spot Prices
4.1.2 Backwardation and Contango
4.2 Sources of Index Return
4.2.1 Spot Return
4.2.2 Roll Yield
4.2.3 Collateral Yield
4.2.4 Diversification and Rebalancing Return
4.3 Commodity Futures Excess Returns
4.3.1 Insurance Perspective in the Theory of Normal Backwardation
4.3.2 Hedging Pressure Hypothesis
4.3.3 Theory of Storage and Convenience Yield
4.3.4 Weather Fear Premium
4.4 Comparison of Commodity Indices
4.4.1 Commodity Index Components
4.4.1.1 Reuters/Jefferies CRB Index
4.4.1.2 S&P GSCITM
4.4.1.3 Dow Jones-AIG Commodity Index
4.4.1.4 Deutsche Bank Liquid Commodity Index
4.4.1.5 Rogers International Commodities Index
4.4.2 Risk and Return Comparison
4.5 Criticism
5 Commodity Futures and Traditional Asset Classes in a Portfolio Context
5.1 Commodity Futures vs. Traditional Asset Classes
5.1.1 Evidence Supporting Commodity Futures as an Asset Class
5.1.2 Traditional Assets: Equity and Bonds
5.1 Comparison of Commodity Futures and Traditional Assets
5.1.1 Risk and Return Comparison
5.1.2 Asset Classes and the Business Cycle
5.1.3 Correlation Between and Amongst Different Asset Classes
5.2 Portfolio-Optimization with Commodity Futures
5.2.1 Commodity Futures as an Inflation Hedge
5.2.2 Commodity Futures and the Efficient Frontier
5.3 Criticism
6 Conclusion
6.1 Résumé and Target Achievement
6.2 Perspectives
Objectives and Research Themes
The key objective of this study is to investigate how commodities as an asset class influence the risk-return-ratio of a traditional portfolio in a passive investment strategy over various periods of time, including different stages of the business cycle.
- Fundamentals of portfolio management and commodity markets
- Different investment exposures to commodities (Futures, Index, Stocks, Funds, Physical)
- Return decomposition of commodity futures (Spot, Roll, Collateral yield)
- Empirical analysis of commodities as an independent asset class
- Optimization of traditional portfolios through the inclusion of commodities
Excerpt from the Book
1.1 Problem Definition and Ambition
Historically, commodity investments were eschewed by many investors due to their unique properties and their reputation for high volatility and riskiness. The weak performance of most commodities since the beginning of the 1980s and in contrast, the positive stock market performance are additional reasons for investors’ lacking interest.
In the past few years, however, an increasing amount of attention has been devoted to commodities as traded assets. For instance, the estimated amount of long-term investor capital tied to the Standard & Poor’s Goldman Sachs Commodity Index (S&P GSCI™) and similar instruments exceeded $130 billion in 2007, up from about $2 billion in 1996. More specifically, as of September 2004, the Goldman Sachs Commodity Index (GSCI) increased its investments from $8 billion in 2000 to more than $25 billion. The number of global institutions with exposures to the GSCI consequently increased from 50 in 2000 to an estimated 150 institutions. Another $8 to $10 billion in assets was tied to the Dow Jones–AIG Commodity Index (DJ-AIG), up from just $200 million a few years ago. Moreover, December 2004 estimates suggest that pension and mutual funds increased their investments in commodity indices from about $15 billion in the middle of 2003 to $40 billion at the end of 2004. Additionally, the Harvard University Endowment which is by many regarded as an indicator of progressive thinking in institutional portfolio management, had in 2004 already bound 13% of its funds in the commodity sector which corresponds to just under $3 billion of its 2004 $22.6 billion endowment.
Summary of Chapters
1 Introduction: Discusses the historical context, rising institutional interest in commodity investments, and the research objectives of the study.
2 Portfolio Management: Details the fundamental concepts of risk and return, Modern Portfolio Theory (Markowitz), and Capital Market Theory (CAPM).
3 Commodities: Defines commodities, categorizes them into classes (Energy, Metals, Agriculture), and explores the economics and participants of commodity markets.
4 Investing in Commodity Futures Indices: Analyzes the mechanics of commodity futures, the sources of index returns, and compares various commodity indices.
5 Commodity Futures and Traditional Asset Classes in a Portfolio Context: Compares commodities with traditional assets (stocks/bonds) regarding performance, diversification, and inflation hedging potential.
6 Conclusion: Summarizes the key findings regarding the role of commodities in portfolio optimization and provides future perspectives.
Keywords
Commodities, Portfolio Management, Modern Portfolio Theory, Commodity Indices, S&P GSCI, DJ-AIG, Risk, Return, Diversification, Inflation Hedge, Futures Contracts, Backwardation, Contango, Business Cycle, Asset Allocation
Frequently Asked Questions
What is the primary focus of this work?
This study focuses on the role of commodities as an asset class within a portfolio management context, specifically investigating their impact on the risk-return-ratio of traditional portfolios.
What are the central themes of this research?
The research covers basics of portfolio management, commodity market dynamics, the mechanics of investing in commodity indices, and the diversification benefits of adding commodities to a traditional stock and bond mix.
What is the primary research goal?
The objective is to analyze whether commodities, when added to a passive investment strategy, provide diversification benefits and how they perform across different stages of the business cycle.
Which scientific methods are employed?
The study relies on Modern Portfolio Theory (MPT), Capital Market Theory (CAPM), and empirical analysis of historical return and risk characteristics of commodity indices versus traditional asset classes.
What topics are discussed in the main part?
The main part covers the fundamental concepts of MPT, definitions and classes of commodities, sources of commodity index returns (roll yield, etc.), and the performance comparison between commodities and traditional assets.
What keywords characterize the study?
Key terms include Commodity Futures, Portfolio Optimization, Diversification, S&P GSCI, DJ-AIG, Inflation Hedge, and Risk-Return-Ratio.
How does the convenience yield affect the market?
The convenience yield is a premium for holding physical commodities. A high convenience yield often leads to backwardation, where futures prices are lower than spot prices.
Why is the "roll yield" significant for commodity investors?
The roll yield is a key component of return in futures-based indices. It is positive in backwardated markets and negative in contangoed markets, directly influencing the performance of passive commodity investments.
- Quote paper
- Friederike Erhorn (Author), 2008, Commodities as an Asset Class in Portfolio Management, Munich, GRIN Verlag, https://www.hausarbeiten.de/document/170194
