Commodities Show Their Hedge Quality Amid Equity Weakness

Mar. 1.11 | About: PowerShares DB (DBC)

Last week, all major global stock markets registered loss: Frontier stocks (NYSEARCA:FRN) lost most -- -2.6%, followed by Emerging market stocks (NYSEARCA:VWO) -- -1.89%, and U.S. stock markets (NYSEARCA:VTI) -- -1.73%. REITs also showed their weakness. Commodities, however, showed their hedging nature, gaining 3.42%. Gold (NYSEARCA:GLD) gained 1.46%. Other fixed income ETFs all had positive gains too. For a more detailed performance update, please refer to here.

The following table shows the trend scores for all major asset classes we monitor.

Assets Class Symbols 02/25
Commodities DBC 16.74% 13.62% ^
US Stocks VTI 13.05% 14.82% v
US Equity REITs VNQ 12.41% 14.34% v
International REITs RWX 11.37% 11.76% v
Gold GLD 9.84% 8.93% ^
International Developed Stks EFA 9.77% 10.71% v
Emerging Market Stks VWO 7.08% 7.87% v
US High Yield Bonds JNK 5.55% 5.5% ^
International Treasury Bonds BWX 2.85% 2.86% v
Frontier Market Stks FRN 1.08% 2.41% v
US Credit Bonds CFT 0.76% 0.38% ^
Emerging Mkt Bonds PCY 0.07% -0.07% ^
Treasury Bills SHV 0.03% 0.01% ^
Total US Bonds BND -0.04% -0.49% ^
Intermediate Treasuries IEF -0.52% -1.33% ^
Municipal Bonds MUB -1.08% -1.17% ^
Mortgage Back Bonds MBB -1.21% -1.51% ^
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The trend score is defined as the average of 1,4,13,26 and 52 week total returns (including dividend reinvested).

We pointed out the role of commodities in asset allocation of a portfolio several months ago. The following table shows the performance of two portfolios using a tactical asset allocation strategy: one has five core asset classes, eash of which is represetned by a single ETF, as its candidate funds: U.S. equity (VTI, SPY), Foreign equity (VEU, EFA), Emerging market equity (VWO, EEM), U.S. REITs (IYR, VNQ) and fixed income (BND, AGG). The other has six core assets that includes an additional commodity index ETF (NYSEARCA:DBC) as its sixth asset.

The following table compares the performance of two moderate portfolios for these two plans.

Portfolio Name 1Yr AR 1Yr Sharpe 3Yr AR 3Yr Sharpe 5Yr AR 5Yr Sharpe
Six Core Asset ETFs Tactical Asset Allocation Moderate 16% 120% 10% 82% 15% 100%
Five Core Asset Index ETF Funds Tactical Asset Allocation Moderate 13% 97% 10% 85% 13% 85%
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Adding commodity (DBC) as an extra asset enables portfolio Six Core Asset ETFs Tactical Asset Allocation Moderate to gain commodity exposure in various periods. For example, the portfolio invested DBC in 10/2007 and it lasted till 9/30/2008, allowing it to capture some of the commodity upside. Same since the beginning of this year. It does make 2% extra annualized return in such a portfolio, compared with Five Core Asset Index ETF Funds Tactical Asset Allocation Moderate that has no commodity exposure at all.

It is clear that adding commodity as a candidate asset for an asset allocation strategy does increase the return and Sharpe ratio (thus, risk adjusted return). However, to achieve this, one should follow a systematic asset allocation strategy like the one mentioned above and handle commodity and other asset classse exposures carefully.


MyPlanIQ does not have any business relationship with the company or companies mentioned in this article. It does not set up their retirement plans. The performance data of portfolios mentioned above are obtained through historical simulation and are hypothetical.

Disclosure: I am long IYR, DBC, GLD, SPY.