Both green and brown commodities matter: A portfolio diversification approach

This study evaluates the effectiveness of a balanced investment approach that straddles the divide between green and brown economies for the 2007-2025 period. Specifically, we examine the effectiveness of green commodities in diversifying brown commodities portfolios and vice versa, using unconditional and conditional tests for portfolio diversification benefits with and without short selling. The assessment is anchored to standardized commodity futures contracts, thus controlling for potentially spurious diversification gains driven by fundamental differences in heterogeneous asset classes. We account for different investment horizons and the perspectives of speculators and hedgers separately. The commodities examined are integral to the energy transition and energy security, which grounds our policy recommendations. We find that combining investments in brown and green commodities is more effective at reducing the fundamental level of risk (hedging) than at increasing the risk-return trade-off offered by brown and green portfolios separately, especially for medium- and long-term investment horizons; that greater uncertainty underscores the effectiveness of green-brown diversification; and that policies limiting short selling in commodity markets have an adverse effect on speculators. Our findings endorse a balanced investment approach to achieve energy security and transition simultaneously.