Structural Sources of Return and Risk in Commodity Futures Investments

Figure 1 reviews just how superior that performance has been: from December 2001 through April 2006, the Goldman Sachs Commodity Index (GSCI) returned 23.1% per year while the S&P 500 returned a more modest 4.9% per year. Given these returns, commodity investing has become a sign of sophistication. Commodities can give turbo returns if things go wrong for equities and bond markets, stated the chief investment officer of a large British pension plan, as quoted in Rees (2006). The significant growth in commodity index investing is shown in figure 2. New commitments from pension funds have fueled some of this growth. Even normally cautious British pension funds are following the more adventurous US precedents and are allocating assets to commodities: the Sainsbury fund has targeted a 5% exposure, the British Telecom fund just under 3%. ... Global pension funds are estimated by investment consultants Watson Wyatt to be worth $16 trillion and if they, like the BT fund, were to allocate 3% to commodities, this would amount to $500bn cascading into what have been quite narrow markets, noted a Financial News (2006) story. Because commodity index investing has grown from an obscure, niche strategy to a more widely accepted investment, there has been a need to better understand the drivers of historical commodity returns and risks. An investor would presumably then be in a better position to make informed judgments on the future prospects of a commodity investment. This article will provide the busy reader with a summary of the new research on this topic.