They’re Back! Post-financialization Diversification Benefits of Commodities

Abstract

Do alternative assets such as commodities improve portfolio diversification? The empirical evidence is generally positive but mixed, and almost exclusively focuses on U.S. data. Using several distinct commodity indexes over the period 1993-2019, we investigate the case of an investor in Canada, a commodity-currency country where equities are already exposed to commodity beta. We use spanning tests and several out-of-sample performance measures for both risk-averse and disappointment-averse investors. Overall, we find that while the diversification potential of commodities was limited in Canada before and during financialization, the post-financialization period offers new opportunities. The evidence suggests that portfolio performance is significantly improved using some, but not all, commodity indexes. Thus, the choice of a relevant commodity index matters as a vehicle for diversification. Finally, compounding an international component to the sectorial diversification of the portfolio can significantly improve its performance.