A small allocation to commodities is justified based on their diversifying properties, but this year’s strong performance is unlikely to continue, Schroders’ multi-asset team has claimed.
Alastair Baker and Patrick Brenner, two managers on the team, said many investors had moved underweight or eliminated commodities from their portfolios, based on extreme underperformance since 2011 and a high correlation with equities.
More recently, however, commodities, as measured by the Dow Jones-UBS Commodity index, have enjoyed a stronger 2014, outperforming equities and bonds in the first half of the year.
“In light of recent performance, we have examined the commonly held rationale that an allocation is justified because commodities diversify and offer equity-like returns,” added Messrs Baker and Brenner.
“We found a stronger case for the diversification properties of commodities, but [due to various factors] a weaker case for equity-like returns.”
According to the pair, the current correlation of commodities with equities and bonds is close to zero, back within its long-term average range of +0.2 to -0.2.
“In a portfolio context, we find that for the majority of the time, commodities improve risk-adjusted returns but there are also long periods when they are detrimental,” the pair said.
“In the current environment, we recommend a small allocation due to their diversifying properties and the continued global economic recovery, which may provide support to prices.”
Within the group’s multi-asset portfolios, commodities remain a neutral allocation, reflecting continued uncertainty surrounding agricultural prices, resulting from unpredictable weather patterns, and Chinese policy, which could improve sentiment towards industrial metals in the short term.
Breaking down the sector, the managers said they were more positive on energy due to attractive carry on oil and gas futures.
“Spare capacity remains well managed as Saudi Arabia continues to exert control over the crude oil market, meaning we do not anticipate a dramatic fall in prices despite the risk of Libya or Iran increasing production,” they said.
“We have downgraded agriculture to negative on the basis that supply appears ample and there remains a substantial weather premium already built in, particularly in soybeans.”
Elsewhere, the pair are positive on emerging market and commodity currencies for carry purposes, noting attractive valuation levels, positive momentum, a friendly economic environment and lower political risks.
“So far it has largely been carry and sentiment rather than fundamentals that have driven emerging markets currency returns,” they added.
