By Brad Zigler
Financial advisers used to recommend a basic "60/40" portfolio: Allocate 60% of your money to stocks, and put the other 40% in fixed-income securities – meaning corporate or Treasury bonds.

You might tweak your investment portfolio allocation around the edges a little, allowing for a cash hoard or a dollop of Gold, but that was about as fancy as investment management advice ever got.

Recently, as exchange-traded products (such as the Gold ETFs and commodity-tracking funds) have proliferated – either carving markets into thinner and thinner subslices or opening up previously inaccessible asset classes – portfolio allocation has gotten more complex.

Further spurring investors to rethink their portfolio asset allocations are growing inflation concerns, as well as the sterling investment results obtained by the Yale and Harvard endowment funds. The two universities, operating with a very "long-term" horizon, use alternative investments to slice, dice and rejigger portfolio risk. Portfolio allocation has been critical to their success.

However, private investors hoping to mimic these endowment portfolios are often left scratching their heads when they consider the so-called "real assets" allocations. Specifically, some investors have begun pondering the utility of replacing their Gold allocation with the broader-based commodity exposure favored by institutional portfolios.

From an efficiency standpoint, the question basically boils down to this: Can exposure to a single commodity – say, gold – provide the desired diversification benefit? Or must a full basket of commodity futures be employed in your allocations?

Take the roster that makes up the S&P/GSCI Commodity Index (formerly the Goldman Sachs Commodity Index). GSCI is a production-weighted index comprising two dozen commodity futures traded in New York, Chicago and London. US crude oil contracts get the greatest weighting (39.5%). The European benchmark – Brent crude – accounts for a further 13.6%.

The first non-energy input is corn, in at No.7, with a 3.4% weighting. Gold is a middle-size component of the index, accounting for nearly 3% of the benchmark's weight. Feeder cattle, lead, silver, cocoa bring up the rear of the 24-item list, each getting a weighting of 0.5% or below.

Using the GSCI as a good (and commonly used) proxy for the broad commodity markets, which is the better diversifier – Gold or commodities?

The correlation between GSCI and gold is not particularly strong, which reflects the broad-based index's diversity. But over the past three years, gold's correlation to other asset classes has also been low – on average, half that of GSCI's. That makes gold a better portfolio diversifier, at least recently.

Gold's lower correlation to other asset classes – the fact that it typically bears little relation to their changing prices than does the commodity fund – means risk is lowered. (Statisticians measure portfolio risk as the variance, or "Standard Deviation" from the average price over a period of time). That also helped make for a better performance, too.

An endowment-style portfolio that allocated, say, 50% to equities, 30% to fixed income, and 20% to real assets such as precious metals, commodities and real estate would have fared better over the past three years if gold were used in the real asset slot rather than GSCI exposure.  Continued...