Commodities are an important alternative asset class that has attracted interest from institutional investors for its potential to bring diversification with respect to equities and bonds in a policy portfolio and to hedge inflation risk. They encompass a large variety of products, ranging from energy sources (oil, gas, etc.) to precious or industrial metals (gold, platinum, copper, aluminium,etc.), raw food and agriculture products (corn, sugar, coffee, cotton, rubber, etc.) and livestock. Organized commodity markets have been around a long time, and the first standardized futures contracts, which are the ancestors of modern derivative products, were written on commodities.
In financial markets, commodities are typically invested through futures contracts, as opposed to being physically purchased. This has implications for performance analysis since portfolio returns are impacted by the slope of the term structure of futures prices, in addition to capturing changes in the spot price of the underlying physical asset: roll returns are positive for a downward-sloping term structure and negative for an upward sloping one.
EDHEC-Risk Institute has been doing research on commodity investing as part of its broader research programme on factor investing, with the aim of identifying robust and economically justified sources of performance that can be exploited in passive strategies. Beyond term structure effects, there are hedging pressure effects, related to backwardation and contango, and momentum effects similar to those encountered in equities. It also appears that there is room for factor-timing strategies that take advantage of predictability patterns.
EDHEC-Risk Institute benefited from the continued expertise of its research associate Hilary Till, co-founder and principal of Premia Capital, a proprietary investment and research firm focused on the natural resources futures markets. She is the co-editor of Intelligent Commodity Investing, a bestseller for Risk Books.