Much of the academic research on commodities has focused on the impact of including an allocation to long-only commodity strategies in a portfolio. Joelle Miffre and Adrian Fernandez-Perez add to the literature with a paper on the performance and volatility of long-only and long-short commodity portfolios, as well as their conditional correlation with equities (represented by the S&P 500 Index) as well as bonds (represented by the Barclays Capital U.S. Aggregate Bond Index).
The study—“The Case for Long-Short Commodity Investing,” which appears in the Summer 2015 issue of The Journal of Alternative Investments—covered two periods and 27 commodities. The first period began on January 5, 1979, and the second period began on October 2, 1992. Both ended on March 25, 2011.
Study Results
Following is a summary of the authors’ findings:
- Long/short portfolios based on momentum, term structure and hedging pressure offer better performance than their long-only counterparts. For example, during the period 1992 through 2011, 96 percent of the long/short commodity portfolios studied generated Sharpe ratios that exceeded that of the S&P-GSCI.
- The conditional volatility of long-short commodity portfolios was less than that of long-only portfolios.
- In periods of turmoil in equity and fixed-income markets, as contagion spreads across markets, the volatility of long/short commodity portfolios rose less than that of long-only commodity portfolios.
- The conditional correlation of the S&P 500 with long/short commodity portfolios (at 0.00, on average) were lower than those measured relative to long-only commodity indexes (at 0.15), suggesting that the risk diversification benefits of commodity futures are stronger within long/short portfolios.
- In periods of high volatility in equity markets, the conditional correlation between the S&P 500 and long-short commodity portfolios based on the positions of hedgers and speculators decreased. This is good news for equity investors, because it is precisely when the volatility of equity markets is high (for example, following the demise of Lehman Bros.) that the benefits of diversification are most appreciated. Relative to long-only strategies, the diversification benefit of long/short portfolios is greater for stocks than for bonds. In other words, bond investors should be indifferent between long-only and long/short allocations to commodities.
