The Handbook of Commodity Investing

CHAPTER 10

The Diversification Benefits of Commodity Futures Indexes: A Mean-Variance Spanning Test

Bernd Scherer, Ph.D.

Managing Director

Global Head of Quantitative Structured Products

Morgan Stanley Investment Management

Li He, Ph.D.

Quantitative Research Analyst

Deutsche Asset Management

It is well known that commodity investment provides diversification benefits to a portfolio. (See, for example, Abanomey and Mathur¹; Anson²; Gorton and Rouwenhorst³; Jensen, Johnson, and Mercer⁴; and the CISDM Research Department.⁵ Commodity futures tend to have equity-like returns, and are negatively correlated with stocks and bonds. When the returns on bonds or equities are low, the returns on commodity futures might be high. Thus, adding commodities in the investment universe makes it possible to achieve higher returns of the whole portfolio without increasing risks. Furthermore, commodities might help investors hedge against inflation since commodities tend to have higher returns when inflation rises, while bonds and equities tend to perform worse with rising inflation. Investors are therefore getting more interested in the statistical and economic foundations of commodity investing. In this chapter, we investigate whether commodities extend the investment universe for U.S.-based investors. In other words, does the inclusion of commodities into portfolios lead to statistically significant improvements in the efficiency (best risk-return trade-off) of an investor's portfolio?⁶

The outline ...