Portfolio investment: Are commodities useful?

This paper examines the usefulness of commodities in an investor's portfolio. Using data on three generations of commodity indices and 15 individual commodity futures for 1991-2015, we find that incorporating most commodity products does little to improve the portfolio's Sharpe ratio especially in an out-of-sample context. The only exception is the third-generation commodity index that is based on a momentum strategy and can substantially enhance portfolio performance. When estimation errors are reduced using a shrinkage estimator, the resulting optimal portfolios are more diversified and stable over time, and importantly, commodities play a much smaller role in terms of risk reduction in portfolios.