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Broad Commodities: An Often-Overlooked Source Of Diversification

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By Nitesh Shah and Jeremy Schwartz, CFA

Commodities person outperformed each awesome plus people successful nan past 2 years by double-digit margins.1 This was peculiarly awesome successful 2022 erstwhile each awesome plus people posted ample losses but commodities posted important gains.2 2022 was a clear-cut lawsuit for diversifying a accepted portfolio of stocks and bonds pinch commodities. Beyond tactical opportunities, world investigation has highlighted nan advantages of utilizing wide commodities arsenic a staple constituent successful semipermanent strategical plus allocations. However, adjacent to half of nan investors precocious surveyed person nary vulnerability to commodities.3 Recent awesome capacity is changing nan temper rapidly, pinch 45% of those not invested successful commodities now considering investing.4 We believe, whether you look astatine caller aliases semipermanent data, nan lawsuit for wide commodity inclusion successful a portfolio is compelling. In this blog series, our nonsubjective is to laic retired nan galore actual reasons why a wide commodity finance tin beryllium additive to a portfolio, starting pinch its diversification superpowers.

Quantitative analyses show that wide commodities are a very powerful root of diversification successful a multi-asset portfolio:

  • Broad commodities are positively skewed erstwhile equities are negatively skewed.
  • They grounds debased correlations to astir of nan accepted plus classes.
  • They stay uncorrelated successful a situation and tin supply alleviation to a portfolio successful geopolitical crises.

Positive Skew, Protection against Exceptional Events

Looking astatine nan distribution of monthly returns of nan Bloomberg Commodity Total Return Index and nan S&P 500 Total Return Index since January 1960, we observe that:

  • The returns of commodities and equities deviate from a normal distribution.
  • The returns of equities are negatively skewed (-0.495 alternatively of zero for a normal distribution), meaning that location is much weight connected nan antagonistic broadside of nan distribution. On nan contrary, commodities are positively skewed (+0.855), meaning that ample affirmative returns thin to beryllium much communal for commodities than ample antagonistic returns erstwhile it is nan contrary for equities.

Overall, this intends that, historically, we tin observe that commodities’ losses person been little heavy and ample gains much predominant than for equities.

In 2022, an power situation catalyzed by nan Ukraine penetration sent nan value of earthy gas, oil, lipid products, and cultivation products higher. This straight benefited wide commodity indexes, which included these earthy materials. Conversely, wide equity indexes suffered arsenic profit margins were being squeezed by quickly rising input costs. While Europe seems to person been fortunate pinch a mild wintertime - which has allowed it to trim power depletion and build inventory - nan Ukraine penetration is acold from over, and further power value shocks can’t beryllium ruled out.

While capacity distributions are important, nan comparative narration betwixt those 2 distributions is moreover much important for investors.

Commodities Offer Diversification from nan Main Asset Classes

Broad commodity futures contracts indexes show very debased correlations pinch astir of nan main plus classes. Commodities are negatively correlated to U.S. Treasuries and U.S. firm bonds. They besides connection a debased relationship to equities and U.S. high-yield bonds.

It is worthy noting that this very debased relationship has been observed by academics arsenic well. Low correlations person been observed by Bhardwaj, et al., 2005, Edwards & Liew, 1999 and Levine, et al., 2018, among others.

Figure 1: Correlation betwixt Main Asset Classes

Correlation betwixt Main Asset Classes

In nan first phases of nan COVID-19 pandemic, correlations of galore assets rose. Panic selling, followed by indiscriminate buying fueled by quantitative easing, drove those correlations higher. However, successful nan past year, nan relationship betwixt commodities and equities has fallen again to a normal level. Looking astatine regular correlations complete nan past year, nan relationship betwixt U.S. equities and wide commodities is backmost to 14%.6

The correlations betwixt commodities and emerging marketplace equities (19%6), U.S. Treasuries (5%6), and U.S. firm bonds (9%6) person besides remained highly low. These debased correlations erstwhile again make a compelling lawsuit for commodities arsenic a diversification tool.

Increased Diversification successful Crisis

While its debased relationship pinch equities has ever been a beardown statement for proponents of commodity investments, critics person historically based on that this debased relationship does not clasp successful periods of crisis. Figure 2 shows nan correlations betwixt different plus classes during nan months erstwhile U.S. equities are down -5% aliases much to trial this hypothesis. It is worthy noting that nan relationship matrix is not importantly different from fig 1. Commodities and U.S. Treasuries still connection nan astir diversification versus different plus classes. The relationship betwixt commodities and nan various plus classes remains very low, which should blunt astir critics of that angle.

Figure 2: Correlations betwixt nan Main Asset Classes When U.S. Equities Are Down More Than -5% successful a Month

Correlations betwixt nan Main Asset Classes When U.S. Equities Are Down More Than -5% successful a Month

Digging further into nan comparative behaviour of commodities successful periods of equity crisis, fig 3 illustrates nan capacity of nan Bloomberg Commodity Total Return Index successful nan worst 20 months for nan S&P 500 since 1960. We observe that commodities person offered very beardown differentiation to an investor. Taking nan illustration of nan worst period for equities successful nan past 60 years aliases so, U.S. equities mislaid -21.5% successful October 1987, pursuing “Black Monday.” During that aforesaid month, nan BCOM Index gained 2.1%. This would person provided unthinkable thief to immoderate investor during that month. In fact, commodities person outperformed equities successful 19 retired of those 20 months. In 12 months, commodities person moreover performed arsenic positively arsenic they did successful October 1987.

Figure 3: Broad Commodities Performance successful nan Worst 20 Months for nan S&P 500 since 1960

Broad Commodities Performance successful nan Worst 20 Months for nan S&P 500 since 1960

Diversification pinch nan WisdomTree Enhanced Commodity Strategy Fund

Investing successful wide commodity strategies successful nan U.S. has gotten easier. A revamped WisdomTree Enhanced Commodity Strategy Fund (GCC) attempts to dynamically prime maturities successful an effort to maximize carry, perchance heighten return and trim volatility compared to first-generation wide commodity strategies, which put only connected nan front-end of futures curves. Cumulative capacity since inception has been 33.34% (to January 31, 2023), compared to 13.92% connected nan S&P 500 Index aliases 6.71% connected nan MSCI ACWI Index aliases -17.16% connected nan Bloomberg Global Aggregate Bond Index complete nan aforesaid clip frame. Returns connected nan Fund look to corroborate nan lawsuit for diversification done wide commodities.

The capacity information quoted represents past capacity and is nary guarantee of early results. Investment return and main worth of an finance will up and down truthful that an investor's shares, erstwhile redeemed, whitethorn beryllium worthy much aliases little than their original cost. Current capacity whitethorn beryllium little aliases higher than nan capacity information quoted. Click here for nan astir caller month-end performance.

1 Between 2/10/2021 and 2/10/2023, nan Bloomberg Commodity Index has outperformed nan Bloomberg Global Aggregate Bond Index by 38%, MSCI ACWI (global equities) by 35%, S&P 500 (U.S. equities) by 19%, FTSE EPRA NAREIT Developed (Real Estate) by 24% and Bitcoin by 63%. Source: Bloomberg.

2 Between 12/31/2021 and 12/31/2022, each nan assets successful footnote 1 fell by much than 12%, while nan Bloomberg Commodity Index roseate adjacent to 12%. Source: Bloomberg.

3 Forty-six percent of investors surveyed successful September 2022 said they did not put successful commodities. The survey, conducted by CoreData Research, an independent investigation agency, polled 600 master investors crossed Europe, ranging from wholesale financial advisory firms to wealthiness managers and family offices. The investors surveyed are responsible for astir €710bn successful assets nether management.

4 Twenty-one percent of each study respondents replied “No, but are considering,” while 25% responded pinch a difficult “No.”

5 Sources: WisdomTree, Bloomberg, S&P. January 1960 to January 2023. Calculations are based connected monthly returns successful USD. U.S. Equities stands for S&P 500 Gross TR Index. Broad Commodities stands for Bloomberg Commodity TR Index. Historical capacity is not an denotation of early performance, and immoderate investments whitethorn spell down successful value.

6 Sources: WisdomTree, Bloomberg, MSCI, S&P. December 2021 to December 2022. Calculations are based connected regular returns successful USD. Past capacity is not suggestive of early results.

7 Carry (commodity): output that tin beryllium expected connected a waste and acquisition complete nan finance period, assuming nary alteration successful spot prices, valuation aliases style of futures curves.

8 The front-end of futures curves refers to futures contracts that person shorter maturities.

Additional Sources

Bhardwaj, G., Gorton, G. B. & Rouwenhorst, K. G., 2015. Facts and Fantasies About Commodity Futures Ten Years Later. Yale ICF Working Paper No. 15–18.

Edwards, F. R. & Liew, J., 1999. Managed Commodity Futures. Journal of Futures Markets, vol. 19, no. 4 (June), pp. 377–411.

Levine, A., Ooi, Y. H., Richardson, M. & Sasseville, C., 2018. Commodities for nan Long Run. Financial Analysts Journal, Volume 74, pp. 55–68.

Important Risks and Disclosures Related to this Article

There are risks associated pinch investing, including nan imaginable nonaccomplishment of principal. An finance successful this Fund is speculative, involves a important grade of consequence and should not represent an investor’s full portfolio. One of nan risks associated pinch nan Fund is nan complexity of nan different factors that lend to nan Fund’s performance. These factors see nan usage of commodity futures contracts. In addition, bitcoin and bitcoin futures are a comparatively caller plus class. They are taxable to unsocial and important risks and, historically, person been taxable to important value volatility. While nan bitcoin futures marketplace has grown substantially since bitcoin futures commenced trading, location tin beryllium nary assurance that this maturation will continue. In addition, derivatives tin beryllium volatile and whitethorn beryllium little liquid than different securities and much delicate to nan effects of varied economical conditions. The worth of nan shares of nan Fund relates straight to nan worth of nan futures contracts and different assets held by nan Fund, and immoderate change successful nan worth of these assets could adversely impact an finance successful nan Fund’s shares. Because of nan wave pinch which nan Fund expects to rotation futures contracts, nan value of futures contracts further from expiration whitethorn beryllium higher (a information known arsenic “contango”) aliases little (a information known arsenic “backwardation”), and nan effect of specified contango aliases backwardation whitethorn beryllium greater than nan effect would beryllium if nan Fund knowledgeable little portfolio turnover. Please publication nan Fund’s prospectus for circumstantial specifications regarding nan Fund’s consequence profile.

For definitions of position successful nan charts above, please sojourn nan glossary.

Nitesh Shah, WisdomTree UK Limited

Nitesh Shah, Director of Research, WisdomTree Europe

Nitesh Shah is an worker of WisdomTree UK Limited, a European subsidiary of WisdomTree Asset Management Inc.’s genitor company, WisdomTree Investments, Inc.

Jeremy Schwartz, CFA, Global Chief Investment Officer, WisdomTree

Jeremy Schwartz, CFA, Global Chief Investment Officer

Jeremy Schwartz has served arsenic our Global Chief Investment Officer since November 2021 and leads WisdomTree’s finance strategy squad successful nan building of WisdomTree’s equity Indexes, quantitative progressive strategies and multi-asset Model Portfolios. Jeremy joined WisdomTree successful May 2005 arsenic a Senior Analyst, adding Deputy Director of Research to his responsibilities successful February 2007. He served arsenic Director of Research from October 2008 to October 2018 and arsenic Global Head of Research from November 2018 to November 2021. Before joining WisdomTree, he was a caput investigation adjunct for Professor Jeremy Siegel and, successful 2022, became his co-author connected nan sixth version of nan book Stocks for nan Long Run. Jeremy is besides co-author of nan Financial Analysts Journal insubstantial “What Happened to nan Original Stocks successful nan S&P 500?” He received his B.S. successful economics from The Wharton School of nan University of Pennsylvania and hosts nan Wharton Business Radio programme Behind nan Markets connected SiriusXM 132. Jeremy is simply a personnel of nan CFA Society of Philadelphia.

Original Post

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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