LONG-SHORT COMMODITY INVESTING
Average Weekly Performance of the S&P500 Index, of Long-Only and Long-Short Commodity Portfolios Over the four weeks that followed Lehman Brothers’ demise
2% 4%
-10% -8% -6% -4% -2% 0
2.02% 1.38% 1.46% 2.01%
0.5093 with a range from 0.2711 (for the single-sort momentum strategy) to 0.6302 (for the single-sort hedger- based strategy). These Sharpe ratios always substantially exceed those of long-only benchmarks. In the context of multi-asset
-1.24% -1.72% -0.77% -0.36% -4.73% -6.42% -8.18%
class investment, the relationship between the conditional volatility of commodity investments and that of traditional investments – as well as the conditional correlations between commodity investments and traditional asset classes – have important implications for risk management and diversification. The averages of the conditional
Long-Only Portfolios Source: EDHEC Risk Institute We also analyse the conditional
correlations of these long-short and long-only commodity portfolios with traditional asset classes, using the Standard & Poor’s 500 Index (S&P500) for equities and the Barclays Capital US Aggregate Bond Index for fixed income products. In terms of stand-alone
performance and as previously reported in the literature, long-short commodity portfolios are found to dominate long-only commodity indices. The average mean excess return of the single-sort long-short portfolios equals 7.99% a year and
Long-Short Commodity Portfolios
volatilities of the long-short commodity strategies studied here range from 15.09% to 17.61% a year and are less than the average of the conditional volatilities of the S&P-GSCI, which stands at 20.81% – these differences are statistically significant. The equally-weighted
portfolio of the twenty-seven commodities is found to have a conditional volatility of 11.28%. The conditional volatilities of the long-short commodity
strategies are also found to rise by less than that of the S&P- GSCI or the equally-weighted benchmark in periods of increased volatility in equity markets. Furthermore, they fall in periods of increased volatility in fixed income markets at a time when the conditional volatilities of the long-only commodity indices rise. Other things being equal, this is welcome news to long-short speculators as it indicates that they can reduce the total risk of their multi-class portfolios in a more effective way by being long- short commodities as opposed to being long-only. Over the period, the conditional correlations of the S&P500
... long-short commodity portfolios are found to dominate long-only commodity indices
that of the double-sort portfolios equals 9.03% a year. Over the same period, the mean excess return of the S&P-GSCI equals 0.64% a year and that of the long-only equally- weighted portfolio of the twenty seven commodities included in this study is at 4.28% a year. The conclusion is similar once we adjust for risk. The Sharpe ratios of the long-short portfolios average out at
40 March 2012
with the commodity investments studied are low, confirming their strategic role as risk diversifiers. The conditional correlations modelled relative to the long-short commodity portfolios are lower than those modelled relative to the long-only commodity indices, suggesting that the risk diversification benefits of commodity futures are stronger within long- short portfolios. Focusing on the period following the demise of Lehman
Brothers, we observe a sharp rise in the conditional correlations between the S&P500 and long-only commodity indices while those between the S&P500 and long-short commodity strategies remain very low. This documents the much stronger diversification benefits associated with long-short strategies versus long-only indices, in the recent past. The conditional correlations between the long-short and long-only commodity portfolios and the Barclays Capital US Aggregate Bond Index are also found to be low over the period. As previously reported in the literature, the correlations with the long-only commodity indices are particularly low. They are
Long-only EW Commodity S&P-GSCI S&P 500
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