Handbook of Finance: Financial Markets and Instruments

Chapter 57. The Fundamentals of Commodity Investments

FRANK J. FABOZZI, PhD, CFA, CPA

Professor in the Practice of Finance, Yale School of Management

ROLAND FÜSS, PhD

Professor of Finance, Union Investment Endowed Chair of Asset Management, European Business School (EBS), International University-Schloss Reichartshausen

DIETER G. KAISER, PhD

Director Alternative Investments, Feri Institutional Advisors GmbH and Research Fellow, Centre for Practical Quantitative Finance, Frankfurt School of Finance and Management

Abstract: According to the academic literature, investments in commodity markets are considered an effective way for investors to diversify traditional portfolios. The diversification benefits of commodities come from their low (and sometimes even negative) correlation with equity and bond markets, as well as from their high positive correlation with inflation. Therefore, during times of price increases, commodities as real assets can function as effective inflation hedges. Moreover, the low correlation with stocks and bonds remains even in downward-trending markets (that is, during phases when it is needed most). However, because commodities can be characterized as a heterogeneous asset class, commodity sector risk and return profiles can vary quite significantly, and may even move in opposite directions. In addition, the complexity of commodity investments can be revealed when considering the different ways investors can obtain exposure to this asset class. Commodity stocks, ...