The Handbook of Commodity Investing

CHAPTER 19

Efficient Frontier of Commodity Portfolios

Juliane Proelss

Research Assistant

European Business School

International University Schloss Reichartshausen

Denis Schweizer

Research Assistant

European Business School

International University Schloss Reichartshausen

We have known since Markowitz's seminal paper on portfolio theory that diversification can increase portfolio expected returns while reducing volatility.¹ However, investors should not blindly add another diversifier² to their portfolios without careful consideration of its properties in the context of the portfolio. Otherwise, the diversifier may not improve the risk-return profile of the portfolio, and may even worsen it. This raises the question of whether commodities really improve the performance of a (mixed) portfolio.

Before examining this question further, we define which assets are considered commodities. Normally there are two types that can be included in a portfolio: (1) “hard” commodities, nonperishable real assets such as energy (e.g., oil), industrial metals (e.g., aluminum), precious metals (e.g., gold), and timber, and (2) “soft” commodities, perishable and consumable real assets such as agricultural products (e.g., wheat) and livestock (e.g., live cattle).³ Using commodities as a financial investment opens up a whole new universe of potential assets. But what makes a new asset or asset class a good investment and a “real” portfolio diversifier?

WHAT TO LOOK OUT FOR

Investors should consider carefully ...