Spicing Up a Portfolio with Commodity Futures: Still a Good Recipe?

Abstract

In this article, the authors investigate whether employing individual commodity futures provides a superior optimized risk–return strategy relative to an equity portfolio, given the recent rise in correlations between commodity and equity markets. They first construct Markowitz mean–variance optimized portfolios of commodity and financial futures contracts within sample and then evaluate their subsequent out-of-sample performance using various time periods, targeted risk levels, and rebalancing frequencies. These portfolios generally outperform benchmark equity indexes, both in terms of return and risk levels. The portfolios also exhibit lower tail risk (reduced potential extreme losses) relative to the equity indexes. These findings support the use of commodity futures for both diversification and portfolio optimization purposes and illustrate appropriate application metrics. Moreover, the results are superior to using the commodity index approach emphasized by most previous studies.