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

Abstract

We investigate whether employing individual commodity futures provides a superior optimized risk-return strategy relative to an equity portfolio, in spite of recently increasing correlations between commodity and equity markets. We first construct Markowitz mean-variance optimized portfolios of commodity and financial futures contracts within sample. We then evaluate their subsequent out-of-sample performance using various time periods, targeted risk levels, and rebalancing frequencies. These portfolios generally outperform benchmark equity indices, both in terms of return and risk levels. These portfolios also exhibit lower tail risk (reduced potential extreme losses) relative to the equity indices. 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.

Keywords: commodity futures; portfolio optimization; tail risk

JEL Classification: G10; G11; G13