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A fundamental lesson emerging from the 2008-09 economic crash is that only a few strategies provide meaningful diversification from equities when severe contagion strikes. Standard risk management suffers accordingly, with substantial portfolio losses.
Even absolute-return hedge funds purporting to provide positive returns failed to protect investor capital—although losses here generally were much less than the 50-plus percent plunge that occurred in equity markets. This situation led to a substantial loss of investor wealth, a reduced chance to attain investment goals (and for pension plans, to meet legal liabilities) and a wake-up call for investors who have been applying traditional portfolio models based on a relatively static framework such as the Markowitz portfolio model. Instead, a dynamic asset allocation approach would have been much better [Mulvey et al. 2006, 2008].
This paper discusses the advantages of commodities futures, and managed futures in general, as bona fide stand-alone investments and as meaningful diversifiers within a portfolio of traditional assets. The managed futures category of hedge funds performed particularly well during the 2008-09 crash periods; in fact, it was the sole hedge fund category with positive performance in 2008-09.
We have seen similar results in previous crash periods including the Asian currency crisis in 1997-98; the Russian debt debacle and LTCM in 1998-99; and the technology bubble and crash and the 9/11 disaster in 2001-03. The positive performance can be attributed to several factors: 1) the ready ability to go long or short depending upon economic and other circumstances; 2) the availability of deep liquidity allowing for dynamic asset allocation; and 3) the opportunity to take advantage of volatility via rebalancing gains and regime changes. Each element provides a small advantage. When combined, however, a portfolio of commodities tactics can substantially improve overall investment performance, especially when traditional assets are doing poorly.
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1 Recent problems occurred with MF Global.
2 Interest rates on 10-Year U.S. government bonds have dropped from 15.84 percent in September 1981 to less than 2 percent recently.
3 The S&P GSCI is the most popular commodities index product, with over $100 billion tracking the index.
4 Clive Capital has been a successful hedge fund investing in commodities markets.
5 Trend-following and momentum tactics are based on differing rules and underlying philosophy.
6 A dynamic long-only commodities index was created by SummerHaven, with an investable ETF whose symbol is USCI. The SummerHaven approach is long-only and employs tactics that are somewhat different than the ones described in this paper, although we suspect the motivations are similar in spirit.
7 Most commodities tactics do not depend upon a relative value approach; for example, trend followers will go long a commodity when the current price exceeds a moving average of past prices.
8 The Ulcer Index measures both the length and depth of drawdown over time.
9 In an early study, Lintner  showed the advantages of commodities funds for improving performance in conjunction with traditional assets.
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