Alpha, Beta and Commodities

Abstract

The author starts with the observation that passive commodity investments have enjoyed four years of impressive returns and asset growth. Though there has been significant intellectual discourse on the subject, the author believes that one should consider the time horizon of the investment in more depth. The paper begins by re-visiting commodities beta sources with updated data through the continued bull market of 2005, identifying the key limitations of passive commodity investments. It then outlines why and how an active commodity portfolio may earn superior absolute or risk-adjusted returns relative to passive commodity investments. The paper concludes by outlining a variety of diversification characteristics investors may find important from exposure to commodities beta, and then questions whether adding incremental amounts of alpha to a selected beta source will allow the investor to achieve returns that maintain portfolio hedging characteristics but with an enhanced risk/return profile.