John Kemp is a Reuters market analyst. The views expressed are his own.
Continued under-performance by the main commodity indices during Q1 should convince any remaining holdouts that passive investment does not work and will never provide a satisfactory return over the medium to long run.
Some firms are promoting the concept of “enhanced beta” strategies that aim to provide a decent return by beating an index or a blended benchmark. But the performance of the main commodity indices has been so poor there is no reason why investors should want to replicate it, whether in enhanced form or not.
Commodities can provide a very attractive return, but investors must embrace a fully active strategy (either selective long-only or preferably full long/short) in order to achieve it. Any other strategy is bound to disappoint.
While many institutional investors have been wary about active management, skeptical about “stock picking” and hedge fund-type strategies, there really is no choice.
In the first three months of the year, broad-based commodity indices such as the S&P Goldman Sachs Commodity Index and Dow Jones-UBS Commodity Index failed to benefit materially from either exceptional liquidity conditions or an improving global economic outlook.
U.S. equity markets notched up their best first quarter ever, according to The Wall Street Journal (“That’s a wrap: Stocks register a record first quarter”, March 30).
But apart from a very good start to the year, when commodity prices leapt on Jan. 3, returns to commodity indices have been poor. In fact the jump on the first day of the year accounts for more than half of all returns so far. Since the second day, Jan. 4, total returns on the S&P 500 index have been almost 11 percent, according to Thomson Reuters data. And returns on the GSCI? Just 2.4 percent. The more diversified Dow Jones-UBS index actually fell 1.5 percent.
Commodity indices failed to rally strongly despite almost ideal conditions. Continued support from the Federal Reserve. Another massive liquidity injection by the European Central Bank. A brightening outlook for the U.S. economy. Geopolitical tensions and a string of supply disruptions in the Middle East. Fears about shrinking spare capacity.
It was a good quarter for anyone with exposure to the spot price of oil. But many other index elements had a lacklustre performance or worse.
But this under-performance should not have come as a surprise. Passive commodity indices have failed to match the performance of equities over any realistic time horizon: 20 years, 5 years, 2 years, or the last quarter.
Active is the Only Approach
Commodity indices do not offer much in the way of diversification from macroeconomic and equity market shocks. They do not match, let alone outperform, the return on equities. And their potential as an inflation hedge remains unproven. They have certainly failed to benefit from the massive creation of liquidity in recent months.
There are excellent returns available for investors in the commodity markets. But those are returns to skill. They accrue to investors and fund managers able to spot turning points and time the markets, using either fundamental analysis or momentum-based strategies.
In contrast, holding a basket of commodity futures for months and years hoping for “roll returns” or spot appreciation is a recipe for disappointment. Equity investors have made up for all their losses since the financial crisis. Most long-term investors in passive commodity funds remain far underwater.
It is time to give the indexing approach a decent funeral. It simply does not work.