Objective

Approach:

Based on the AiLA allocation strategies, construct a portfolio with the following target properties,
- Maximum percentage of capital allocated is 100%.
- Notional long vs short exposure is zero at portfolio level, i.e. referred to as net-zero exposure.
- Net-zero exposure also to be achieved within different commodity groups of the portfolio.
- The net-zero criteria is only approximate, where a certain level of deviation from zero is acceptable.
- If necessary, not allocating to a certain commodity group is acceptable, e.g. due to the lack of AiLA allocations.
The commodity groups are defined together with two target parameters,
- Max total allocation of the commodity group.
- Max net-zero deviation limit of the commodity group.

Questions:

Commodity Groups

Base Metals

Precious Metals

Grain

Energy

Soft

Livestock

Net-Zero Criteria

Net-zero criteria achieved well at group and portfolio level for the default commodity groups, before the liquidity constraints are imposed.

However, criteria cannot be guaranteed on each single day when liquidity/rebalancing constraints are included (similar at portfolio level).

Smaller Deviation Limits

Setup

Net-zero portfolio based on default commodity groups.
Max total (group) allocation is unconstrained, i.e. max = 100%.
Max net-zero (group) deviation limit same for all groups and reduced from 100% (unconstrained) to 5%.

Tendency of portfolio performance

Reducing the limit by which the commodity groups are allowed to deviate from net-zero,
The risk adjusted return tends to become lower,
However, several historical drawdowns also being reduced, e.g. 2020 March.

Smaller Groups

Setup

Same as for reducing max net-zero deviation limit results above.
Except, using a larger number of smaller commodity groups (S).
Grain and Energy (default) groups are split into one group per commodity, e.g. WTI is one group.
Grain and Energy groups chosen due to more different as well as liquid contracts, compared to other default groups.

Tendency of portfolio performance

Introducing many/smaller groups tend to limit the occurrence of simultaneously being long and short.
Tends to be more similar to portfolio of individual assets, i.e. no net-zero group constraints.

Summary

An AiLA portfolio with net-zero criteria at a commodity group level appears achievable within relatively small deviations specified by the input parameters, given the set of commodities and groups investigated.
The liquidity constraint cause some additional deviation, beyond the limits specified by the input parameters, however, to a relatively modest extent.
The portfolio performance tends to decrease on a risk adjusted basis with a decreasing net-zero deviation limit, however, often also with historical drawdowns being reduced.
The number/size of the commodity groups tends to be a compromise between sufficiently many assets, that can be simultaneously long and short, and similarity/correlation between the asset PnL.

Mixed Compromise Scenario?

No max group allocation limit.
Net-zero group limits:
- Energy: 10% (many correlated contracts)
- Others: 20% (more diverse groups).
Slightly less historical drawdowns, while most of unconstrained performance?

Commodity Groups with Net-Zero Exposure