Risk-Based Commodity Investing

Abstract

Pursuing risk-based allocation across a universe of commodity assets, we find diversified risk parity (DRP) strategies to provide convincing results. DRP strives for maximum diversification along uncorrelated risk sources embedded in the underlying commodities. A straight-forward way to derive uncorrelated risk sources relies on principal components analysis (PCA). While the ensuing statistical factors can be associated with commodity sector bets, the corresponding DRP strategy entails excessive turnover because of the instability of the PCA factors. As an alternative, one may run the DRP strategy relative to common commodity risk factors that have been orthogonalized such that they exhibit a minimum tracking error to the original factors. The DRP strategy then builds on a more stable anchor that implicitly allows for a uniform exposure to commodity risk premia.