Ben Collins, PhD
November 5, 2021

Commodities are a very diverse asset class, and that diversification brings many expected benefits. Different sources of supply and demand across sectors allow exposure to unique avenues for inflation and global growth, and for active management, unique sources of alpha relative to stocks and bonds. However, the methodology used to construct even the simplest portfolio of commodities may fail to capture that intrinsic diversity.

It is well-known that in the most cited commodities indices, the majority of the risk comes through energy commodities. This limits their investors’ exposure to the other unique channels for inflation and growth that come through the agricultural and metals sectors. There is another component, however, that can add to the concentration issues and is discussed less often. Focusing on the Bloomberg Commodity Total Return (BCOM) Index specifically, asset weights float during the year according to the ratio of the current contract price to a reference value set in January1. During the year, the asset weights are never rebalanced towards the original value. This approach subjects the exposures of the index to the price trajectories of the individual commodities. For typical market conditions, these fluctuations might seem acceptable. However, the recent rally in natural gas prices is producing a case where the effects are quite dramatic.

Supply shortages in Europe and Asia have caused those natural gas markets to see extreme price increases, with some European benchmarks in October almost 400% higher than in January. Partly to reflect export demand, and partly due to a milder supply crunch of our own, US prices of natural gas have also increased significantly. The reference price of natural gas used in the BCOM index for 2021 is under $3, while as of the start of October, prices had almost doubled from there, fluctuating around $6. Accordingly, the holdings of natural gas in BCOM have increased from their baseline value of 8% to around 13-14% of the total portfolio.

Of course, as the market returns were increasing the position size, they also delivered significant positive returns to the index in September. Should the trend continue, the index could generate even larger returns from this position as it takes an even higher percentage of the index allocation. However, if prices turn around, the index could experience just as sizable returns and elevated risk on the way down. Even if prices stay elevated, the position size will likely remain high for the rest of 2021 and continue to crowd out any developments in the rest of the asset class that could offer diversifying performance. Already for September, we estimate that, for a portfolio that rebalances asset weights only annually, natural gas alone would have contributed over 40% of the total portfolio’s volatility in that month. Figure 01 below depicts the BCOM weights and the estimated risk contributions for a hypothetical annually rebalanced index portfolio.

(January 2021 - September 2021)

Estimated Weights and Risk for an Annually Rebalanced Commodity Index Portfolio

*The Annually Rebalanced Commodity Index was calculated by First Quadrant, LLC, by estimating returns from a portfolio invested in January according to the 2021 BCOM targets and that is not subsequently rebalanced to those targets.

Sources: First Quadrant, LLC, Bloomberg, and Commodity Research Bureau (CRB)

Because of their generally unbalanced risk allocations, benchmarks like BCOM can offer a distorted view of the wider commodities landscape, limiting the diversifying properties that make commodities such a potentially useful portfolio component. The feature we have discussed above, the high concentration that the indices are currently experiencing due to the natural gas markets, can, at times, make those problems even worse. We believe most investors would be better-served by commodity strategies that address these issues by targeting more balanced exposures across commodities and steadier risk delivered over time, while still providing the desired inflation-hedging characteristics.

To learn more about how we approach these enhancements, please see “Commodities: Hedging Inflation Is Easy, You Need Returns” (2016), “Opportunities in Commodities” (2015), “Inflation Concerns and the Role of Commodities” (2014), and “Balanced Risk Commodities” (2010).

1The final weight for an asset is also relative to the price ratios of the rest of the assets, as the resulting portfolio weights are scaled to equal 100% each day.

For index definitions and trademark language used in this publication, please visit for further information.

Past performance is no guarantee of future results. Potential for profit is accompanied by possibility of loss. Commodities trading involves substantial risk of loss.
© First Quadrant, LLC, 2021. Intended for Institutional and Qualified Eligible Persons Use Only. The views expressed are the views of First Quadrant, LLC, only as of the date shown and are subject to change without notice based on market and other conditions. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice, recommendation, or solicitation of any particular security, strategy or investment product. This publication has been prepared without taking into account your objectives, financial situation or needs. Before acting on this information, you should consider its appropriateness having regard to your objectives, financial situation or needs. It is your responsibility to be aware of and observe the applicable laws and regulations of your country of domicile. All material has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.