Reappraising the case for commodities
Sentiment towards commodities has turned decidedly sour over recent years and investors are questioning the role of commodities in strategic asset allocation. Duncan Lamont, Head of Research and Analytics, returns to first principles and reassesses why commodities could merit a place in portfolios in the first place.
12 September 2016
- Commodities have been one of the star performers of 2016 yet investor sentiment has rarely been more negative. Previous poor performance means they remain one of the few asset classes globally that can lay a claim to being cheap
- While downside risks remain, commodities are not only cheap in a historic context but also relative to equities and marginal costs of production
- Commodities provide a hedge against rising inflation that few other asset classes have been able to demonstrate historically. Those that have are currently either very expensive or no longer fit for purpose
- There is a relatively weak relationship between commodities and equities. They can offer significant diversification benefits even if it is unrealistic to expect them to hedge equity market crashes
- Commodity volatility is on a par with equities. However, they can improve expected risk-adjusted returns even on the basis of a relatively conservative return outlook
- Commodities represent a relatively inefficient asset class which offers relatively high potential excess returns for skilled managers.
A rollercoaster ride
Commodity investments have been on a rollercoaster ride. Investor interest sparked into life in the 2000s as a raft of academic research emerged extolling the virtues of commodities as an asset class1.
Historic equity-like returns and significant diversification benefits relative to equity and bonds were key attractions as was the potential inflation-hedging quality of the asset class.
For a number of years, commodities exceeded these expectations as insatiable demand from emerging markets and China in particular spurred a super cycle in commodity prices. Between December 1999 and June 2008, the Bloomberg commodity Index (BCOM, previously known as the Dow Jones-UBS index) delivered total returns of around 15% a year with similar volatility to equities, during a period where equities barely broke even2.
1 “Facts and Fantasies about Commodity Futures” by Gary Gorton and K. Geert Rouwenhorst, Wharton School, University of Pennsylvania, February 2005, is one of the most famous. http://fic.wharton.upenn.edu/fic/papers/06/0607.pdf
2 BCOM was established in 1991 and is more diversified by commodity than the longer standing S&P GSCI index (GSCI, established 1970), which has an over 70% allocation to the energy sector. In this paper we have used BCOM to represent commodity returns where possible as it is more reflective of the broader commodity universe. However, when longer term analysis has been carried out we have used the GSCI as a result of its longer track record.
Important Information: This communication is marketing material. The views and opinions contained herein are those of the author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. It is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a reliable indicator of future results. The value of an investment can go down as well as up and is not guaranteed. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Some information quoted was obtained from external sources we consider to be reliable. No responsibility can be accepted for errors of fact obtained from third parties, and this data may change with market conditions. This does not exclude any duty or liability that Schroders has to its customers under any regulatory system. Regions/ sectors shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. The opinions in this material include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change. To the extent that you are in North America, this content is issued by Schroder Investment Management North America Inc., an indirect wholly owned subsidiary of Schroders plc and SEC registered adviser providing asset management products and services to clients in the US and Canada. For all other users, this content is issued by Schroder Investment Management Limited, 31 Gresham Street, London, EC2V 7QA. Registered No. 1893220 England. Authorised and regulated by the Financial Conduct Authority.