Have Commodities Futures Lived Up to Their Promise?

Whatever happened to the dream of commodities futures? They were supposed to turn the ordinary investor’s portfolios into a sophisticated hedge fund, promising stock-like returns with low correlation to equities.

Many seminal studies purporting to show these benefits, followed by the proliferation of mutual funds and exchange-traded portfolio products targeting retail investors, have popularized the strategy.

But now some thought leaders in the investment blogosphere are starting to pick apart the claims made for commodities futures funds, which generally purchase Treasury securities as collateral for futures contracts in energy, agriculture, livestock, industry and precious metals.

Tadas Viskanta of the popular Abnormal Returns blog initiated the latest round of rethinking. Viskanta hearkened back to the hype of 2006, following a study underscoring commodities futures’ equity-like performance but negative correlation to stock and bond returns.

This research, by Gary Gorton and K. Geert Rouwenhorst, was “was picked up by multiple media sources as a major discovery,” Viskanta wrote at the time, commenting now that “new ‘discoveries’ in the financial markets are indeed rare.”

Indeed, Gorton and Rouwenhorst were not alone in thinking this.

A 63-page paper, also written in 2006, by Ibbotson’s Thomas Idzorek and commissioned by PIMCO (which launched one of the first commodities futures funds, and the industry’s biggest) similarly concluded that historical studies and future simulations suggested high risk-adjusted returns for the asset class. (Many other studies, written before and after that time, reached similar conclusions.)

Looking back from today’s vantage point, however, commodities futures have not fared well. The PIMCO Commodity Real Return Strategy Fund (PCRDX) is down more than 12% over the past five years, and down 63% for the decade ending Dec. 31.

PCRDX differs from other such funds in that it invests its collateral in inflation-protected Treasuries, rather than ordinary T-bills, as a means of accentuating its inflation protection.

The inflation that many investors have feared has not come about in the past several years, thus magnifying the pain for PCRDX investors. Those who put their money in the leading commodities futures ETF, the PowerShares DB Commodities Index Tracking Fund (DBC), whose collateral is in short-term Treasuries, fared far better — gaining nearly 16% over the past 5 years (and up 3.55% in the nearly eight years since the fund’s inception); the ETF lost 9% in the past year while PCRDX lost 17.25% in that time.

Viskanta cites current research from UBS projecting high volatility and low returns for the asset class.