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The Tactical and Strategic Value of Commodity Futures

Last Updated on 10 February, 2024 by Rejaul Karim

The paper “The Tactical and Strategic Value of Commodity Futures” authored by Claude B. Erb and Campbell R. Harvey delves into the intricacies of estimating the prospective performance of long-only investment in commodity futures.

Despite historically minimal average annualized excess returns of individual commodity futures and their low correlation with each other, a rebalanced portfolio of commodity futures has shown the potential for equity-like annualized excess returns. The study emphasizes the significance of certain security characteristics, such as the term structure of futures prices, and specific portfolio strategies that have historically yielded above-average returns.

The authors underscore the need to avoid simplistic extrapolation of historical returns and to strike a balance between reliable and potential sources of return.

This comprehensive analysis provides an extended version of the authors’ 2006 publication in the Financial Analysts Journal, offering crucial insights into strategic and tactical asset allocation in commodity futures, diversification return, trading strategies, and more.

Abstract Of Paper

Investors face a number of challenges when seeking to estimate the prospective performance of a long-only investment in commodity futures. For instance, historically, the average annualized excess return of individual commodity futures has been approximately zero and commodity futures returns have been largely uncorrelated with one another. However, the prospective annualized excess return of a rebalanced portfolio of commodity futures can be equity-like. Certain security characteristics, such as the term structure of futures prices, and some portfolio strategies have historically been rewarded with above average returns. Avoiding naïve extrapolation of historical returns and striking a balance between dependable sources of return and possible sources of return is important. This is the unabridged version of our 2006 publication in the Financial Analysts Journal.

Original paper – Download PDF

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Author

Claude B. Erb
TR

Campbell R. Harvey
Duke University – Fuqua School of Business; National Bureau of Economic Research (NBER)

Conclusion

In conclusion, Erb and Harvey’s “The Tactical and Strategic Value of Commodity Futures” offers valuable insights for investors navigating the challenges of forecasting the performance of long-only investments in commodity futures. Despite historically minimal individual commodity futures returns and their low correlation, the study highlights the potential for equity-like returns in a rebalanced portfolio of commodity futures.

The authors emphasize the significance of specific security characteristics, such as the term structure of futures prices, and portfolio strategies that historically yield above-average returns. Caution is advised against simplistic extrapolation of historical returns, and finding a balance between dependable and potential sources of return is crucial.

This comprehensive analysis provides essential guidance for strategic and tactical asset allocation in commodity futures, covering diversification return, momentum, market timing, and various trading strategies.

Related Reading:

The Fundamentals of Commodity Futures Returns

Predicting Commodity-Futures Basis Factor Return by Basis Spread

FAQ

Q1: What is the key insight from the paper “The Tactical and Strategic Value of Commodity Futures” regarding the performance of long-only investments in commodity futures?

The paper highlights that while individual commodity futures historically show minimal average annualized excess returns and low correlation, a rebalanced portfolio of commodity futures has the potential for equity-like annualized excess returns. The key insight is the importance of specific security characteristics, such as the term structure of futures prices, and certain portfolio strategies in achieving above-average returns.

Q2: Why do the authors caution against simplistic extrapolation of historical returns in the context of commodity futures investments?

The authors emphasize the need to avoid simplistic extrapolation of historical returns because individual commodity futures have historically exhibited an average annualized excess return of approximately zero, and their returns have been largely uncorrelated with each other. The paper underscores the importance of considering factors like the term structure of futures prices and striking a balance between reliable and potential sources of return to make informed investment decisions.

Q3: How does the paper contribute to guiding investors in asset allocation and trading strategies related to commodity futures?

The paper contributes by providing essential insights into strategic and tactical asset allocation in commodity futures. It covers various aspects such as diversification return, momentum, market timing, and specific portfolio strategies that have historically yielded above-average returns. By cautioning against simplistic approaches and emphasizing a balanced consideration of dependable and potential sources of return, the authors offer valuable guidance to investors navigating the challenges of forecasting the performance of long-only investments in commodity futures.

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