Commodities Asset Allocation

I was recently given this scenario and would appreciate any advice as to how I would begin to approach and structure the answer. Currently in a totally unrelated field, looking to make the move into asset management.

You're an analyst working with a family office. You're considering allocating 5% of the portfolio to commodities (current allocation is 0%), long-term view. You need to make the case for this to the fund manager. What are the advantages/disadvantages you would have to consider?

Portfolio currently includes: - Property - Hedge Funds - Fixed Income - Private Equity - Cash - Equities

My first few thoughts were: - The family office can tolerate moderate risk as they have exposure to hedge funds and private equity, which are riskier assets than F.I and property.

  • Why diversification into commodities and why now?
    • Which commodities?

I guess my first stumbling block was not knowing much about commodities or commodity indicies. Where would one go to find appropriate indicies that would help with this case?

Any input would be great.

3 Comments
 
Best Response

Two things make the case for putting commodities into a portfolio

  • Generally speaking certain classes of commodities traditionally have been good inflation hedges (gold for example)
  • Commodity returns are not highly correlated with equities which provides a diversification benefit and pushes out the efficient frontier (this is basic financial theory, however i tend to somewhat question this to the extent that when you are in a highly stressed market correlations start to move towards 1, basically when you need diversification the most)
  • Liquidity is better generally in things such as commodity ETFs and such vs. private equity and hedge funds and you can get out faster at a better price, but from an asset allocation standpoint that might not be the answer to the question but something to consider considering whats the point in having a great asset if you cant get out when you need to
 

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