• Commodities as a whole were down in 2014 but depending upon which index you benchmarked to that loss may have been anywhere from -17% to -33%
  • Commodity returns can vary widely depending on the underlying exposure to each sector
  • This difference in sector makeup can cause profound differences in long-term results, but we won’t know in advance which methodology will perform the best

On occasion we get a question about commodities and what their returns look like. 2014 provided an interesting case study in just how general the term commodities exposure can be. We’re all well aware of the widely publicized fall in oil prices of over 50% during the last year, but what did that mean for someone holding commodities exposure? Well, it depends.
Much like the ambiguous term alternative investments, commodities exposure could mean different things to different people. Some investments may target narrow subsets of the market, while others may make bets based on the recent momentum within specific sectors. Yet, even for those investments looking to simply track an index, results varied widely.
Depending upon your specific investment target you may have seen losses in 2014 of anywhere from -17% on the Bloomberg Commodity Total Return Index to -33% on the S&P Goldman Sachs Commodity Index (GSCI) Total Return Index. How can exposure to the same asset class vary by such a dramatic magnitude? This difference can be predominantly attributed to index construction.
In the commodity investment world there are three main index benchmarks commonly referenced: Credit Suisse Commodity Benchmark Total Return, S&P GSCI Total Return and the Bloomberg Commodity Total Return. Similar to what we see in other areas of the investing world — such as what constitutes a Value stock — each benchmark may not have the exact same construction parameters.
The three indexes listed have different methodologies for how they arrive at their specific commodity allocations. For example, the Credit Suisse Commodity Index looks solely at world production quantity to arrive at its sector weights and does not rebalance due to price changes whereas the Bloomberg Commodity Index Total Return uses a 1/3 weight of world production value and 2/3 market liquidity and rebalances annually. This can lead to drastic differences in weighting to different sectors.
As we can see in the chart above, the S&P GSCI has more than double the exposure to the Energy sector when compared to the Bloomberg Commodity Index. Oil’s dramatic fall, being a large portion of the Energy sector, means an investor who was looking to capture returns in line with the S&P GSCI index suffered to a far greater degree than the investor tracking the Bloomberg Commodity Index, as most other commodities had far less dramatic moves in 2014.
These differences in construction have led to enormous dispersions in long-term returns. For the 16 years starting in 1999 (longest track record available) the cumulative return for the S&P GSCI Index came in at 64%, or about 3.16% annualized per year, compared to a cumulative return of 281% or 8.72% annualized return for the Credit Suisse Commodity Index. Yet, we all know past performance is no guarantee of future results; the commodity sector mix that worked best over a previous period may not be the one that works best over future periods.
It turns out understanding index construction and methodology is just as important in the commodities space as every other portion of your portfolio in order to ensure you’re capturing the desired dimensions of expected return.
Source: Morningstar Direct 2015. Indexes are unmanaged baskets of securities that are not available for direct investment by investors. Index performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. All investments involve risk, including loss of principal. Commodity-related products carry a high level of risk and are not suitable for all investors. The commodities industries can be significantly affected by commodity prices, world events, import controls, worldwide competition, government regulations, and economic conditions.