The whole area of alternative investments is a major talking point in both academia and the industry these days. Not that this is something new, of course. There has always been some kind of alternative investing going on. For many years it was the commodity market which was the main focus, often through Commodity Trading Advisors (CTAs) – though that is rather a catch-all category for what today would just as likely be considered hedge funds as in many cases similar trading strategies are employed. Today alternative investing has expanded to include a great many different areas of investing, to include the currency market, and commodities have remained a focal point thanks to the growth of ETFs.
The fun part of being a PhD student is that you pick up all kinds of interesting information through your research, attending conferences, and sitting in on seminars. This week I’ve been in a workshop put on by a visiting faculty member, part of which focused on alternative investing, with a specific concentration on commodities. Naturally, he told us all about various research into the subject matter, and included a significant bit of his own.
Here’s the unexpected conclusion he presented to us. Despite the fact that commodities have been hyped for years as providing diversification for investors who otherwise play stocks and bonds, the evidence doesn’t support the case – at least when looking at them in aggregate (as we would with a commodity index or ETF). This is especially understandable in recent times given how commodities have become much more correlated with stocks and bonds of late, at least partly thanks to the increased use of commodities in asset allocation (decisions which drive the choice to invest in financial assets correspond to those to invest in hard assets).
The one exception to this discovery is gold. The research supports the idea that diversification into gold is actually worthwhile. No doubt there are many gold bugs out there saying that was obvious all the time.
By the way, one of the major selling points in investing in commodities is the rates of return of commodity indices like the GSCI. These indices, however, have a built-in upside bias based on the way they are constructed. In other words, they don’t really tell the full story about what commodities are doing, but they are great for selling a good story to drive investment.
So, if the commodity market isn’t so great for alternative investment, is it time to look for an alternative alternative?