CFA Level 1 - Alternative Investments
Forms of Commodity Investing
Investing in commodities comes in two forms: passive and active:
- Passive investing is a strategy used by investors who are using commodities as a risk diversification tool. For example, when inflation picks up, it tends to hurt fixed income securities and equities to some extent. However, prices of commodities tend to rise during these periods. This helps diversify your portfolio. Commodity investing has long had a reputation for exceptional volatility and risk but there is now a small but growing number of excellent, high-quality index-based commodity funds available that provide a relatively conservative way to invest in commodities. The management attempts to minimize price fluctuations and provide overall risk management in several ways. The selection and weighting of assets in a portfolio are typically reviewed annually or when there is a major change in an industry or even a drastic change in usage of any given commodity. This provides some overall risk reduction in commodity index funds and makes them suitable for investment by investors with limited commodity backgrounds.
Index funds usually consist of long positions on the contracts. Short positions are usually not taken.
- Active investing or actively managing a position in the commodities market can provide good performance results. In periods of economic growth, commodities are in strong demand to satisfy production needs. Because commodity or raw material prices tend to move more quickly in reaction to economic fluctuations than do the prices of the related finished goods, an active approach could lead to economic gains if trading activities are closely monitored and managed by the investor.