Commodities: strategic allocation

November 8, 2010

Commodity futures are likely to continue to exhibit low correlation with traditional asset classes while delivering positive returns, making them valuable diversifiers for plan sponsors’ portfolios.

The most appropriate way for most plan sponsors to invest in commodities is through futures, whose returns derive from roll return, price return, and collateral return.  Our research indicates that the best approach is to invest in a transparent long-oriented trend-following or momentum strategy that is fully collateralized in U.S. government bonds and diversified across a wide variety of commodities.  If deviation from a benchmark return is a concern, investors might consider the Dow Jones-UBS Commodities Index.  However, benchmark investors should be aware that they may experience higher volatility and lower overall returns than a trend-following or momentum strategy.  Overall, we believe that the average pension plan would benefit by investing between 3% and 7% of plan assets in commodities.