Efficient use of commodity futures in diversified portfolios

We provide evidence on the role of commodity futures in portfolios comprised of stocks, bonds, T-bills, and real estate. Over the period investigated (1973-1997), Markowitz optimization over a range of risk levels gives substantial weight to commodity futures, thereby enhancing the portfolios' returns. We find dramatically different results when we use a simple ex ante measure of monetary stringency to dichotomize the sample into expansive-versus-restrictive monetary-policy periods. In periods characterized by restrictive monetary policy, commodity futures are shown to have substantial weight in the efficient portfolios, with significant return enhancement at all levels of risk. In periods characterized by expansive monetary policy, commodity futures are shown to have little or no weight in the efficient portfolios, with no return enhancement at all levels of risk.