Commodity Derivatives: Markets and Applications

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Commodities Within an Investment Portfolio

Empirical evidence has shown that commodities as an asset class add significantly to the diversification within a portfolio given their negative correlation with financial assets.

SYNOPSIS The purpose of this chapter is to outline the role of commodities within an investment portfolio.

 

This chapter will be of interest to those who:

• wish to invest in the asset class but are unsure of how the different instruments work;

• are already invested in commodities but would like to deepen their understanding of the market and raise their awareness of other investment opportunities;

• are employed on the “sell side” of the financial sector and wish to further their understanding of the suite of products being sold to the investment community.

The chapter begins by defining the main investor types and then outlines the principal benefits of investing in commodities. The discussion develops the relative merits of the types of commodity exposure. A significant amount of money invested in the market is referenced to commodity indices. The sources of the index returns, such as the roll yield, are analysed. The most common method of taking exposure to a commodity index is by use of a total return swap and the chapter includes a fully-worked example.

As the investment community has become more confident in the “vanilla” mechanisms of commodity investment, the range of structured investments has widened. A number of structures are presented, and, where ...