Commodity Futures Investing: Complex and Unique

About the Author

Wesley R. Gray, Ph.D.

After serving as a Captain in the United States Marine Corps, Dr. Gray earned a PhD, and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management that delivers affordable active exposures for tax-sensitive investors. Dr. Gray has published four books and a number of academic articles. Wes is a regular contributor to multiple industry outlets, to include the following: Wall Street Journal, Forbes,, and the CFA Institute. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.

  • trr

    I found this article very illuminating, thank you! However, I don’t see the question of commodities via futures versus via equities settled here. The interesting question is not whether the equities route replicates the futures route. (I don’t see GMO, in the paper you cite, claiming that.) The interesting question is which is better.

    You argue that commodities futures admit a strategy based on momentum and term structure. Well, commodities equities admit a strategy based on momentum and value (as well as the tax efficiency, simplicity, transparency, and liquidity that you mention, and also an equity premium).

    You argue that commodities futures provide diversification whereas commodities equities add more equities risk. But GMO argue that commodities equities also provide diversification, especially on long time frames. Not all equities risk is the same. As for short-time frames, I suppose one might look for crisis alpha or crisis protection, but I don’t believe either (long) commodities futures or commodities equities provide that.

  • Thanks for your comments.

    Clarified the language wrt GMO.

    We discuss the term structure aspect but don’t really discuss momentum in any detail. Based on our work, term structure is a different beast than value or momentum equity premiums. Love to see if you know of research suggesting otherwise.

    Commodity equities are equities. And I think the evidence is clear that comm_eq equity beta risk is the big muscle movement in those assets movements. Commodity futures are futures and their risk premias are driven by spot risk and carry risk as outlined in this article, which seem to be different beasts than equities.

    All that said, if one is specifically interested in inflation hedging (point on the GMO piece), and looking at taxes, transparency, etc., there is a good discussion to be had. However, if you buy commodity equity to get your inflation hedge, but they just stack more equity risk in your portfolio, you might be better off getting your inflation hedge via futures and also getting the genuine portfolio diversification benefits. I could see it going either way depending on circumstance.

  • trr

    Thank you.

    I don’t mean to suggest a relationship between term structure and value or momentum, just that commodities equities can also be refined by strategies.

    You write “equity beta risk is the big muscle movement” (in commodities equities) which suggests they do not offer the genuine portfolio diversification you see in futures. But GMO claim low (or even negative) correlation between commodities equities and the rest of the equity market on a 3-10 year time-scale. That sounds like genuine portfolio diversification to me.

  • Got it.

    I’m attaching some basic stats on the following portfolios from Ken French’s website (1927 to 2015, total returns, gross of fees): French Oil, French Mining, Value-weight CRSP, and SP500.
    1) French oil is the oil sector according to their 30 industry codes
    2) French mining is the mining sector using the same 30 industry codes. Details are here:
    3) VW CRSP is essentially all stocks with market-cap weighting
    4) SP 500 is essentially = VW CRSP

    Some summary stats:
    –high vol, high drawdown 65-75% correlation

    Some 4 factor analysis:
    –vast majority of returns are attributed to beta exposure

    Some 5 yr rolling CAGRs:
    –highly correlated — especially during the first half of the sample
    Some 5yr rolling maxDD:
    –highly correlated across the board

    My conclusion from this analysis is GMO needs to go back to the drawing board and conduct some out of sample testing. I stand by the claim that commodity equity risk is just more beta with more noise.

  • mike

    Great article. When 54% in gov bonds in suggested, is there any specific way to play this? Is a bong fund best?

  • dph


    Are there any ETFs accessible to retail investors that mix equities and commodity futures and thus have a smoother return profile (in theory). Or does this need to be handled white glove for BIG accounts. It’d be nice for equity drawdowns to be mitigated by commodity futures especially if the portfolio (or ETF) knows to tilt toward that if equities reach certain triggers on extreme value or movement. .

  • sixchickensleft

    What’s a “bong fund”? Is that for a really severe market crash?

  • Yes, you forget the drawdown even happened and decide to eat cheetohs that day.

  • Hannibal Smith

    Nice summary! Managed futures are definitely a different beast than pure “buy and hold” spot and roll yields; typically they’ve been trend following instead so you get a muted fat tail. Virtually all of the commodity indexes are “buy and hold”, but one or two is trend following and so is about a handful of funds (none of which have attracted much attention). Fortunately, the whole enchilada of thorny issues involved with commodity indexing has finally been solved by RA.

    If you look at the chart under “Commodity Future Returns versus Other Assets Across Regimes” above, it’s pretty obvious that only one asset is best for different regimes. For commodities, it is high inflation. But as highly correlated cost inputs to a business, commodites are subject to expansion and recession risks which makes them inferior substitutes to holding stocks or bonds during such regimes. So just drill down into individual commodities to find out exactly what the high inflation outperformers are. There is a paper that illustrated per commodity returns during different regimes.

  • trr

    Wow, you’ve dug deep into this. I’d love to hear a response from the GMO authors, but I guess that’s unlikely.

    I’m now (stubbornly) wondering how to get the best of both worlds…. maybe dual momentum GUNR/USCI (and SHY).

    Happy holidays.

  • Citi

    Hello, what would be your answer to the criticism expressed in this paper:
    http:[email protected]/documents/file/plstudy_33_yu.pdf

    1) The front running of indexes such as GSCI might cost up to 3.6% to the ETF type investors.
    http:[email protected]/documents/file/plstudy_33_yu.pdf
    2) The value of total long positions held by index investors and the average estimated ratio of there long positions relative to total open interests increased dramatically over the period of 1999 to 2008. This might significantly reduce risk premium acquired by long only investors.

    I noticed you are recommending GSCI index in your Robust Asset Allocation:

    It does seem to be a poor choice from a first glance. Since it both, suffer from front running significantly and is highly exposed to energy sector. GSCI seems like a volume weighted index, which you mentioned performs worse than equal-weighted indexes.

  • Thanks for sharing.

    We generally use GSCI in tests because it has the longest data path and people are familiar with it. As we explained in our DIY book and in that post you cited, one should consider backwardation/contango , portfolio construction, etc. when gaining exposure to commodities. We also think it makes sense to apply trend on commodity exposures.

    We are expanding our RAA post and I’ll include a note on this

  • Citi

    Someone could make a statement that equity like returns are observed in theoretical academic papers only and such returns were never observed in real world. That those studies are subject to errors and some important aspects of real world were missed to consider (“What you see is all there is” cognitive bias might play its role, authors of scientific papers cannot consider factors that negatively impact returns that they are not aware of).
    My question is, how strong are evidences that theory match empirical reality.

    I’m not making any claims here. This specific question is bugging me a while as I was reading some of the studies on the subject. It’s not easy to find “success stories” in commodity futures long-only type of investing. Are you aware of a fund, ETF or even person or entity that could be an example, not even taking survivorship bias into account, that equity like returns were ever realized by such investments ? The PIMCO PCRIX fund was the only semi-success story I managed to find myself. For the first decade after inception it performed quite well.

  • Hannibal Smith

    The entire hedge fund industry or at least CPOs is full of success stories as that is how they got off the ground in the 70’s and the 80’s. Look up the largest by assets and you’ll generally find them.

  • Hannibal got to the answer before I did. The commodity futures business has typically been private and still is private (for the most part). The track records of some of the longest running CPO/CTAs is on par–if not better than famous equity investors.