Thread by @ReformedTrader

1/ Building a Better Commodities Portfolio (Kay, Levine, Ooi, Pedersen)

"Investors can potentially build a better commodities portfolio that is risk-balanced across sectors and that targets a steady level of volatility through time."

aqr.com/-/media/AQR/Do…

2/ "Because commodities have exhibited low correlations to stocks and bonds, a portfolio comprised of all three has produced higher risk-adjusted returns than a 60/40 portfolio of stocks and bonds alone."

3/ "Commodity returns have historically shown a low correlation to other asset classes. Other common inflation protection assets – such as publicly traded REITs, natural resources equities, and TIPS – have shown far higher correlations to either stocks or nominal bonds."

4/ "During periods of positive inflation surprises, stocks and bonds have historically generated negative real returns, while commodities have performed well."

“Inflation surprise” = realized 12-month inflation minus average 12-month inflation forecast from a year prior

5/ "Using monthly returns (1990-2011), the average pair-wise correlation across ten of the most traded commodity futures was 0.22 vs. 0.62 across ten developed country equity index futures and 0.53 for G6 10-year bond futures. Diversifying across commodity sectors is valuable."

6/ The volatility-targeted, sector risk balanced, drawdown-controlled portfolio improves Sharpe ratios and drawdowns. (The Appendix, in Tweet 5, has methodology details.)

"It requires much more frequent rebalancing and allocates larger weights to less liquid contracts."

7/ High-carry and high-momentum tercile portfolios outperform low-carry and low-momentum terciles.

There may also be some benefit to modifying roll methodology to avoid paying excessive carry and getting picked off by front-runners.

8/ Related research:

Exploiting Commodity Momentum Along the Futures Curves

https://twitter.com/ReformedTrader/status/1268037070276096000

Commodity Futures Risk Premium: 1871–2018

https://twitter.com/ReformedTrader/status/1197396668968128513

Comparing First, Second and Third Generation Commodity Indices

https://twitter.com/ReformedTrader/status/1269090755164778497