The Handbook of Commodity Investing

CHAPTER 18

Sources of Alpha in Commodity Investing

Markus Mezger

Managing Partner

Tiberius Asset Management

Commodity futures are one of the oldest asset classes. Today, commodity futures represent opportunities for active management because of two reasons. First, as we show in this chapter, commodity markets are heterogeneous and cover a broad range of different returns. Therefore, the potential for alpha returns of an actively managed commodity portfolio is comparatively high. Alpha is defined as the uncorrelated excess return of an actively managed commodity portfolio to a commodity index, which serves as a benchmark. The return of an actively managed commodity portfolio can be split into a (1) beta component, which represents the benchmark correlated returns; and (2) an independent residual return, which consists of the alpha return and of a random component.¹

Second, commodity futures as an asset class are predominantly represented by passive commodity index investments. The volume invested in long-only commodity index vehicles is estimated to have risen from $40 billion in 2002 to more than $120 billion at the beginning of 2007. However, commodity indexes suffer some serious shortcomings. The initial weights of the index constituents mostly depend on the monetary value of supply, demand, and liquidity. The yearly changes of these weights are often minor and cannot be considered to comprise changing relative performance trends. Furthermore the commodity indexes are restricted ...