| Commodities still a great portfolio diversifier |
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| 02/07/2006 | |
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Strategic allocations to commodities by institutional investors are too low as the asset class could continue to produce equity-like returns and improve the efficient frontier of investment portfolios, according to a study commissioned by PIMCO, the fixed-income specialist. In this study, which was carried out by Ibbotson Associates, commodities were found to have a very low average correlation to a hypothetical portfolio based on US and international stocks and bonds, as well as cash, and both produced high returns and provided a hedge against inflation. According to PIMCO, this finding supports the claim that commodities provide diversification through superior returns when they are needed most. "Given the inherent return of commodities which is not conditional on skill, there seems to be little risk that commodities will dramatically underperform the other asset classes on a risk-adjusted basis over any reasonably long time period", said Bob Greer, a real return product manager at PIMCO. "If anything, the risk is that commodities will continue to produce equity-like returns, in which case, current forward-looking strategic allocations to commodities are too low." "No matter which set of returns was used in the Ibbotson study, including commodities in the opportunity set improved the risk-return characteristics of the portfolio, usually significantly. Furthermore, commodities played an important and very significant role in the strategic asset allocations. Nevertheless, commodities are still often excluded from the opportunity set of investable asset classes." The study analysed the role of commodities as represented by a composite of four commodity indices based on annual data from 1970 to 2004 so as to reduce any bias occurring in any one index. To project the future potential benefits of commodities in strategic asset allocation, the study included commodities in a hypothetical market portfolio to create a set of expected returns based on the Capital Asset Pricing Model (CAPM). Using conservative expected commodity return estimates relative to historical commodity returns, forward-looking efficient frontiers were then created with and without commodities included in the opportunity set. Using CAPM expected returns, the inclusion of commodities significantly improved the efficient frontier. J.L. |
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