The Asset Allocation Perspective

At Gresham, we hold to some basic, and instructive, truths about Asset Allocation:

• The future cannot be predicted with certainty, but you can prepare for it.
• The most important investment decisions are which asset classes to own and what percentage of a portfolio should be invested in each class.
• To maximize the gain and minimize the loss of a portfolio, an investor needs to diversify investments among different asset classes the returns of which are both positive and uncorrelated.

Our own investment experience has shown us that, in order to effectively disperse risk, investors need to widen their scope beyond stocks and bonds to include other broad asset classes, specifically commodities.

Commodities are a Core Asset Class

Commodities represent a broad asset class that has return and risk characteristics that are comparable to stocks and bonds. They are a “core” asset class, as defined by Mark Kritzman, in that they are:

• Unique. Commodities help investors diversify more efficiently and cannot be replicated with a combination of other assets (for example, stocks and real-estate);
• Useful. Commodities are uncorrelated to other assets, such as stocks and bonds, and they can improve the risk-adjusted return of a portfolio;
• Homogeneous. Commodities, despite representing multiple assets, have the common characteristic of being tangible in form, with prices determined by supply and demand; and
• Capable. The liquidity of commodity futures markets permits significant quantities to be transacted at prices near the markets’ bids and offers.

Commodities Help Diversify Portfolios and Improve Risk-Adjusted Returns

We believe that a well-diversified portfolio will have some mix of stocks, bonds, and commodities. Historically, the recognition of commodities as a “core” asset class by institutional and high net worth investors has been slow. This is changing because:

• Acceptance of Modern Portfolio Theory has led to a better understanding of asset allocation and the role that various asset classes have in an investment portfolio. Commodities increase the risk-adjusted returns of a portfolio and provide inflation protection;
• Commodity futures markets became broad, liquid, and global as activities of hedgers and speculators increased over time;
• The involvement of security industry professionals in the financial futures markets has caused them to look at commodities in the context of asset allocation; and
• Global growth, consumer consumption and global use of tangible commodities have become ever more relevant as the world becomes more integrated and technologically developed.

Commodities can capture return during periods of economic uncertainty

• Inflation Protection. Commodities are tangible goods and, as such, increase in value when inflation increases;
• Geopolitical Uncertainty. Commodities have historically maintained value or increased in value during economic and political crises;
• Uncertainty Concerning the Price of Key Commodities, Such as Oil. Increases in commodity prices, particularly sudden increases, often cause affected stocks to fall;
• Weakness in Leading Currencies. Commodities perform well when paper currencies decline; and
• Natural Disasters. Hurricanes, droughts, floods and other natural disasters tend to increase demand for commodities.

An overview of commodities and ways to gain commodity exposure are described in the next section, About Commodities.