Risk management insights from Markowitz optimization for constructing portfolios with commodity futures

Based upon a Markowitz methodology, this paper considers use of commodities futures as assets to enhance portfolio diversification. A very simplistic methodological approach is chosen to allow various portfolio issues to be highlighted with data from the recent financial crisis. Naïve long-only diversification (with commodities) does not add a great deal of value relative to the event risk that can (and often does) occur. The opposite is concluded for the long/short approach. We find commodities can be key drivers in risk mitigation over time and in crisis conditions when utilized in long/short portfolios. Focus upon crisis risk exposes many of the fallacies inherent to simplistic portfolio creation and management.