NEW YORK — "Looking for a pot of gold" isn't just a figure of speech — it's what institutional investors literally should be doing, according to a new study.
The study, written by Richard O. Michaud, founder and president of New Frontier Advisors LLC, Boston, and sponsored by the World Gold Council, shows that allocating 2% to 4% of total assets to gold futures can add diversification and better risk-adjusted returns.
Mr. Michaud's research found that between Jan. 1, 1974, and Dec. 31, 2005, gold produced an inflation-adjusted annualized return of 2.1%, as measured by the London PM Fix benchmark, compared with a 1.4% return over the same time period for U.S. Treasury bills.
While commodities in general have a very low correlation to traditional asset classes, making them powerful diversifiers, gold's correlation is even lower. Gold generally had a lower correlation to other asset classes than would a basket of commodities as measured by the Commodities Research Bureau index. Gold had a -0.15 correlation to U.S. T-bills, while the basket had a -0.09 correlation. Also, gold had just a 0.07 correlation to U.S. large cap stocks as measured by the Russell 1000 index, while the basket of commodities had a 0.14 correlation.
That's good news for investors seeking to reduce the volatility of their total portfolios. One of the cornerstones of investment icon Harry Markowitz's modern portfolio theory is that a mix of asset classes with low correlations to each other can create an efficient portfolio — one that delivers the highest possible return with the least amount of risk.