The portfolios with commodities produced slightly lower returns. However, they were also more efficient at delivering risk-adjusted returns. Using volatility as the measure of risk, the portfolio with an allocation to the DJ-AIGCI was 8.6 percent less risky, while returns were just 1.2 percent lower. The portfolio with an allocation to the GSCI was 7.9 percent less risky, while returns were just 2.4 percent lower.
 

By focusing only on returns and volatility, investors miss the bigger picture. The high volatility of commodities and their low correlation to equities combine to provide a significant diversification benefit. Consider the following: While the DJ-AIGCI returned 4.4 percent, a 10 percent allocation impacted the portfolio as if it had actually returned 6.7 percent (or 4.1 percent above inflation). The incremental return of 2.3 percent (6.7 minus 4.4) is a “diversification benefit.”
 

The diversification benefit of the GSCI is even greater due to its higher volatility. While the GSCI returned 2.1 percent, a 10 percent allocation impacted the portfolio as if it had returned 5.7 percent (or 3.1 percent above inflation). Thus, the diversification benefit was 3.6 percent (5.7 minus 2.1).
 

When constructing a portfolio, it is important to remember that considering the risk and return of an asset class such as commodities in isolation is a mistake. While commodity returns were poor during this period, including an allocation would have improved the risk-adjusted returns of the portfolio. It is also important to note that this was a period of low inflation, when this portfolio insurance was not needed. There was no guarantee that history would play out that way.

This material is derived from sources believed to be reliable, but its accuracy and the opinions based thereon are not guaranteed. The articles and opinions in this publication are for general information only and are not intended to serve as specific financial, accounting or tax advice. Copyright © 2009, Buckingham Family of Financial Services.  All rights reserved. This material may not be copied or distributed (electronically or otherwise) without the written consent of Buckingham Asset Management. The products or services described herein are available to US citizens and residents only and the information contained is intended for such persons only. No information contained herein is an offer to sell. Investors should read the prospectus of a security prior to making any investments.

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