How much should clients allocate to commodities?

This article is part of
Guide to investing in commodities

How much should clients allocate to commodities?

Commodities as an asset class can act as a useful diversifier in clients’ portfolios, but given the additional risks and a higher level of volatility that commodities can bring, it can be tricky to know just how much exposure clients should have.

The outlook for oil prices has turned more favourable since the start of 2019, points out Aneeka Gupta, associate director of research at WisdomTree.

She says: “Brent oil has witnessed 28.3 per cent price appreciation as of April 2 2019, enjoying its strongest start to the year since 2005, based on quarter one performance.”

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Nevertheless, she says as oil tends to be among the more volatile cyclical commodities, investors should allocate to oil contingent on their risk appetite.

So why invest?

According to Ben Kumar, investment manager at Seven Investment Management, in the early 1990s, multi-asset investors started to get interested in commodities.

Mr Kumar explains: “They liked the data – commodities were not particularly correlated with bonds, equities or property – and they liked the story. Commodities are real-world assets, and should be closely related to inflation over the long term.

“Now, nearly 30 years later, most multi-asset portfolios have a sliver carved out for commodities, and there are a lot more multi-asset portfolios.”

But this has meant that some of the real-world benefits of the commodity markets have vanished as they become "financialised" – that is, influenced by investors rather than the commodity producers and consumers, he says.

He adds: “Commodity products can provide some diversification, but for us, the traditional asset classes of bonds and equities should form the bulk of portfolios.”

Similarly, Peter Elston, chief investment officer at Seneca Investment Managers, observes: “Commodities do not yield anything – in fact, because of storage costs they are negative yielding – so over time, commodity prices will tend to rise with inflation, nothing more.

“Prices are also very volatile, so volatility-adjusted returns from commodities tend to be low."

He continues: “There are times when you can do well from commodities, when investing tactically, and the ideal scenario is currently gold.”

However, he says a strategic allocation to commodities is inadvisable, though he concedes that tactically one can generate decent returns if investing when inflation-adjusted prices are low in the context of long-term history and sell when they are high.

"So, from a tactical viewpoint there are times when you should be exposed to them/have an allocation to them on a tactical basis," he explains.

Mr Elston points out: “When the next recession hits, central banks will want to debase their currencies, making gold more attractive.”

Meanwhile, Patrick Connolly, a chartered financial planner at Chase de Vere, says there is a positive long-term story for investing in commodities based on the theory that demand will increase as global populations increase, and as we see the continued development and infrastructure spend in the emerging markets.

He says: “There is also a strong argument that commodities can provide diversification benefits in an investment portfolio as they typically have a low correlation to other assets, such as shares and bonds.”