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IMCA Annual Conference
The Father of Futures

The Father of Futures

Financial advisors can thank K. Geert Rouwenhorst of the Yale School of Management for the rapid proliferation of exchange traded funds that invest in commodity futures. He was one of the first to consider commodity futures an investable asset class and measure its performance against stocks and bonds, as well as inflation.

Not that commodity futures themselves are new. Cuneiform tablets dating back to 554 BC have been found that were promissory notes for barley. Commodity indexed loans arose in Germany between World War I and World War II that promised the holder a percentage premium over the spot price of goods like Rye and Benzene, according to Rouwenhorst.

“History has shown investors who clamor for protection against inflation go to commodities,” he said. As they do today.

Going back to 1959, commodity futures have received a risk premium (the percentage return over treasurys), adjusted for inflation, of a little more than 5%, similar to equities, according to Rouwenhorst's research. Over the long term, volatility was also similar to that of equities.

So why invest in commodities futures at all, if equities generally provide the same risk-adjusted returns and an inflationary hedge?

Because they don’t march in tandem with other asset classes like stocks and bonds, at least over the long term. “We don’t hold commodities in isolation, so we care about how they behave in the context of other stuff you might own.” Commodity correlations, it turns out, are not that high, and the longer the time horizon, the more negatively correlated to other asset classes they become. Commodities also correlate best with higher levels of inflation over longer time horizons. But aren’t equities supposed to also be an inflation protected investment? Surprisingly, according to Rouwenhorst, the data says otherwise: From 1800 to 2011, stocks had a .03 correlation to inflation. Granted, few stock portfolios will have 211 year time horizons.

Of course, not all commodities are created equal – and in line with fundamental laws of economics, scarcity plays a role. Commodities with lower inventories had an annualized return of 9.3% since 1990, while those with high inventories returned 3.8% over the same time period, without much difference in standard deviation.

How to find commodities with low inventories? Rouwenhorst’s answer may not satisfy traders looking for an edge: you have to go to the market and read the price signals.


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