Commodity Investing: Maximizing Returns through Fundamental Analysis

CHAPTER 21

The Rise of the Indexes

For most of this book we have been taking a do-it-yourself approach to investing. In this chapter we take a well-deserved break and let someone else do the work as we look at passive investments. Some investors may want commodity exposure in their portfolios but are not interested in opening a futures account or tracking petroleum inventories. During the past several years, many investors have been choosing commodity indexes, so that will be our main topic. However, there are a few additional ways investors can obtain exposure, so we will tackle exchange-traded funds, commodity trading advisors, and mutual funds as well.

THE RISE OF THE INDEXES

During the years 2002–2006, a dramatic increase occurred in the level of institutional interest in the commodity sector. This shift was likely a result of investors looking at the historical returns of long-only commodity indexes and finding that they compared favorably to gross equity market returns in both average return and typical levels of risk, but with low levels of correlation to equities. The trusty tool of mean variance optimization meant that this was too good to pass up, and this analysis is fine as far as it goes. However, it misses the source of the returns and does not take likely future returns into account. In this section we discuss the indexes, their composition, their potential role in a portfolio, and their prospects for continued attractive excess returns.

The increased interest in ...