Page 1 of 3 Last week, we learned that commodity futures had finally pulled ahead of stocks in the performance race. But are outsized returns really what investors should seek from their commodity exposure? Or should hard assets play a subtler role in a portfolio? That's why we went to Larry Swedroe, principal and director of Research for the Buckingham Family of Financial Services. Known as a voice of reason in the investing community, Swedroe is a prolific author and one of the most respected financial advisers in the business today. His book on commodities and other alternative asset classes, The Only Guide To Alternative Investments You'll Ever Need, was published by Bloomberg in 2008, and he has two more books on the way soon. Recently, HAI Associate Editor Lara Crigger chatted with Swedroe about the role commodities play in a portfolio, including whether it's worth chasing commodity returns, why he's sworn off ETNs for good and why he remains skeptical about active commodity ETFs. Crigger: Last time we had you on the site, you talked about the usefulness of commodities as a hedge, or an insurance against supply shocks. But do you think commodities can actually add returns to your portfolio as well? Swedroe: The historical evidence is this: Commodities have no real expected return, nor should they. Commodities are an input to economic activity, if you will. Therefore, they should have very low expected real returns. In the long term, they do serve as a reasonable inflation edge, although not a perfect one. There's no guarantee. Just take gold. It was at $300 or so in '82, and 20 years later it was still $300—and we averaged 4 percent a year inflation. So for that 20-year period, you lost 4 percent a year. So in that sense the evidence shows that [even over a] pretty long period, commodities don't even act as a good inflation hedge. That's why, in our previous discussion, I had suggested that commodities should only be used as a means to provide a hedge against some kinds of event risk that can hit either stocks or bonds badly. They can be supply shocks, wars, political risk, those kinds of things. Regardless, you should expect very low correlation between the returns on commodities on average and the returns on your other portfolio options. So it does provide a diversifier, but it's one with a very low expected return. But because of its high volatility, a small allocation to commodities is going to have a significant impact on the returns of a portfolio. Commodities may not deliver great returns, but their impact on the portfolio is bigger than just the return of the asset class itself, which is the mistake many people make. But the only right way to look at things is: When you add an asset to a portfolio, how does that impact the risk and return of the overall portfolio? Crigger: You're a big advocate of using futures over stocks to get your commodities exposure. What are some of your favorite ways to tap into commodity futures? Swedroe: The reason I like futures over stocks is that the correlation of commodity producers' stocks [to the broader stock market], while not that high, is still significantly positive. It's higher than it is to the commodities themselves. With futures, there's much lower correlation, and you get away from the risks of equities themselves, since obviously the stocks of commodity producers contain exposure to beta risk. Right now I think that you should have either the Goldman Sachs or the Dow Jones UBS indexes. Historically the data shows if you added either one, basically you'd have higher overall returns. But my own personal preference would be to use the Dow Jones Index, because it's less weighted toward the energy sector and oil.
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