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By Timothy Strauts | 04-03-2014 11:00 AM

A New Normal for Commodities Funds

Despite their historical diversifying qualities, these funds will maintain a partial correlation with equities as long as investors remain interested.

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Tim Strauts: Commodity funds have become a popular way to diversify investor portfolios, but as we've seen with investor interest, the diversification benefits have been reduced over the last few years. When we look at this chart as you can see that from a period around the late 1980s to the early 2000s commodity funds had a near-zero correlation to U.S. stocks. There was an oscillation, positive and negative, but in general over the long term, there was a zero correlation.

But in the early 2000s, some academic research came out to show this diversification benefit of commodity funds, and as investors saw this research, they started to invest in commodity funds, as you see in the growing assets, all the way up to almost $175 billion around 2010. As investor assets grew, the correlation to U.S. stocks also grew. So we've actually reached a new higher plateau where now commodities funds seem to be oscillating around a 0.5 correlation to U.S. stocks.

It's a clear case of investors using academic research to try to improve their portfolios, but they had the negative consequence of actually changing the market by all investors acting together with everyone investing in commodities funds. So going forward, I would expect that commodity correlations will stay around the 0.5 correlation to U.S. stocks as long as investors still are interested in commodities.

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