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Alternative Beta Strategies in Commodities

Last Updated on 10 February, 2024 by Rejaul Karim

Daniel Ung and Xiaowei Kang delve into the realm of “Alternative Beta Strategies in Commodities” in their incisive study, which sheds light on the multifaceted investment goals that these strategies can fulfill. The authors emphasize the importance of aligning these alternative beta strategies with individual investment objectives and risk preferences.

Examining both the ‘risk-based approach’ aimed at mitigating portfolio risk and the ‘factor-based approach’ focused on earning systematic risk premia, the paper underscores a nascent yet burgeoning concept in the commodities domain. As investors increasingly seek well-diversified portfolios and recognize the influence of systematic risk factors on returns, the emergence of commodity alternative beta products gains momentum.

The study’s investigation unveils the potential advantages of integrating alternative beta strategies into commodity portfolios, particularly in delivering higher returns and lower risk. Noteworthy considerations about the active risks inherent in alternative beta strategies, primarily driven by factor exposures, prompt a prudent approach to leveraging these strategies to improve returns and mitigate risk.

This comprehensive exploration illuminates the evolving landscape of alternative beta strategies, offering valuable insights for asset management and investment in the commodities market.

Abstract Of Paper

Alternative beta strategies can serve a variety of different investment objectives, which may include reducing volatility or achieving tilts to systematic risk exposures. It is therefore essential for investors to examine whether these strategies meet their own investment objectives and risk-taking preferences.

Two main approaches to alternative beta are reviewed in this paper: the ‘risk-based approach,’ which entails reducing portfolio risk; and the ‘factor-based approach,’ which involves enhancing return through earning systematic risk premia, with a focus on the latter. Whilst alternative beta is fairly well established in equity strategy investing, it is still a nascent concept in commodities. However, as a result of investors’ pursuit of better diversified portfolios and a recognition that systematic risk factors explain the majority of returns, the development of commodity alternative beta products is gathering pace. This is not entirely unforseen, as investors now view their investment opportunity in the context of risk premia, rather than individual asset classes. From our investigation in this study, there appears to be potential benefit in allocating into alternative beta strategies as part of a portfolio’s commodity allocation, and we find that combining risk-based and factor-based commodity strategies has historically delivered higher return and lower risk than passive long-only strategies on their own.

Finally, it should be borne in mind that alternative beta strategies often take substantial active risks, which are largely driven by factor exposures. Factor returns can be volatile, and all alternative beta strategies can experience considerable drawdown at times. However, as these risk factors have a low correlation with each other, it may be sensible to combine them in order to improve return and reduce risk.

Original paper – Download PDF

Here you can download the PDF and original paper of Alternative Beta Strategies in Commodities.

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Author

Daniel Ung
CFA Institute; Chartered Alternative Investment Analyst Association (CAIA); Global Association of Risk Professionals

Xiaowei Kang
Erasmus University Rotterdam (EUR) – Rotterdam School of Management (RSM)

Conclusion

In conclusion, Daniel Ung and Xiaowei Kang’s comprehensive study aptly underscores the strategic relevance of alternative beta strategies in the commodities sphere. From a nuanced examination of the ‘risk-based approach’ for portfolio risk reduction to the ‘factor-based approach’ aimed at earning systematic risk premiums, the research unveils the evolving landscape of alternative beta strategies.

This paper serves as a testament to the transformative potential of integrating these strategies into commodity portfolios, offering a promising avenue for investors to achieve enhanced returns and mitigate risk. Notably, the authors’ insightful discourse on the active risks inherent in alternative beta strategies, primarily steered by factor exposures, calls for a prudent and diversified approach to harness these strategies effectively.

By acknowledging the inherent volatility and drawdown potential of factor returns, and the potential benefits of their low correlation, the study encapsulates critical considerations for optimizing risk-adjusted returns in commodity investments.

Ultimately, this research provides invaluable guidance for asset managers and investors navigating the dynamic realm of alternative beta strategies in commodities.

Related Reading:

Technical Analysis, Spread Trading and Data Snooping Control

Evaluating Commodity Exposure Opportunities

FAQ

Q1: What are the main approaches to alternative beta strategies discussed in the paper, and how do they align with investment objectives?

A1: The paper discusses two main approaches to alternative beta strategies: the ‘risk-based approach’ focused on reducing portfolio risk and the ‘factor-based approach’ aimed at earning systematic risk premia. These approaches align with various investment objectives, allowing investors to tailor their strategy based on goals such as risk reduction or achieving specific risk exposures.

Q2: How does the study characterize the development of commodity alternative beta products, and what factors contribute to their increasing prominence?

A2: The study characterizes the development of commodity alternative beta products as a nascent yet growing concept. The increasing prominence is attributed to investors seeking better-diversified portfolios and recognizing that systematic risk factors explain a significant portion of returns. The shift towards viewing investment opportunities in the context of risk premia, rather than individual asset classes, is a driving force behind the development of commodity alternative beta products.

Q3: What are the potential benefits of allocating into alternative beta strategies in commodity portfolios, according to the study’s findings?

A3: According to the study’s findings, there appear to be potential benefits in allocating into alternative beta strategies as part of a commodity portfolio. The combination of risk-based and factor-based commodity strategies has historically delivered higher returns and lower risk than passive long-only strategies alone. The study suggests that integrating these strategies can enhance risk-adjusted returns in the commodity investment landscape.

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