Spot Returns, Roll Yield, and Diversification with Commodity Futures

MARK J. P. ANSON is affiliated with OppenheimerFunds, Inc., in New York. R ecent academic and practitioner Ž research Schneeweis 1996 ; . Schneeweis and Spurgin 1998 has emphasized the diversification benefits of a wide range of alternative investments including managed futures products as well as hedge funds. Many of these alternative investment products are based on active management strategies that often concentrate primarily on financial futures and options markets. Ž However, recent research Halpern and . Warsager 1998 has also focused on the diversification benefits of long-only investment strategies that focus on commodity futures in contrast to financial futures or options based contracts. There are several reasons why an investment in a commodity futures index may be an excellent source of portfolio diversification. First, commodity futures indexes invest only in nonfinancial commodity futures. This is important because the values of financial futures contracts, such as stock index futures or interest rate futures, are determined by the same economic fundamentals that determine the values of stocks and bonds. For instance, the values of these financial future contracts tend to be negatively influenced by the general level of interest rates and inflation rates. Conversely, commodity futures tend to be positively correlated with inflation. Second, commodity futures indexes are designed to be ‘‘long-only’’ investments. In other words, their investment in the commodity futures market is always positive: it is never short the market. As Edwards and Park 1996 noted, one of the issues with managed futures products is that they may hold both long and short speculative positions. Consequently, managed futures vehicles may not be sufficiently invested in the long-only commodities markets at the proper times to offer sufficient diversification benefits for stocks and bonds. The idea of commodity futures index investing is not new. An investible asset may be regarded as a separate asset class and a beneficial part of a diversified investor’s portfolio if they offer unique risk and return properties not easily obtainable with other investments. Under this definition, commodities also certainly qualify as an asset class. Ankrim and Hensel 1993 , Lummer and Siegel 1993 , and Kaplan and Lummer 1997 each concluded that an allocation to the Goldman Ž . Sachs Commodity Index GSCI provides a good diversifier for stocks and bonds within a mean-variance framework. Froot 1995 found that the GSCI is an effective portfolio diversification tool both as an initial hedge and as a secondary hedge after other real assets have already been