Recent months have proven commodity prices higher. In this guest blog, Alessandro Sanos, global director sales strategy & execution, commodities at Refinitiv, examines the performance of commodities.
The current market turbulence and uncertainty is reaching levels we have not seen in decades.
War is back in Europe, supply chains have not fully recovered from the COVID19 pandemic, monetary policy makes it into the evening news, and inflation keeps rising after years of historical low values.
Twelve months percentage change of Consumer Price Index of G20 countries
Given their weak performance over the past years, investors do not always include Commodities in their strategic asset allocations. From an investor's point of view, the relative performance of Commodities is low compared with other asset classes, such as equities and the S&P500.
Looking at the Refinitiv/CoreCommodity CRB Excess Return Index versus the Russell 1000 Index, Commodities have continued to fall since 2008 compared to stocks.
The relative performance of Refinitiv/CC CRB Excess Return Index vs Russell 1000. Start date: 01st January 1994. Source: Refinitiv Eikon
But current high inflation rates renewed the interest in adding Commodities as an alternative investment to hedge against inflation risk, increase portfolio diversification, and provide additional return potential.
Data from recent studies show that an increased allocation to Commodities provides high returns when stock and bond returns are at their weakest, andthat it hedges against increases in inflation.
The latter should not be a surprise.
Looking at the components of the Consumer Price Indices (CPIs), the measure of the evolving cost paid by consumers for a basket of goods and services, most of the weight is usually on real assets. As an example, in the US over 70% of the inflation basket is based on real assets. It makes, therefore, sense to recalibrate portfolios and increase the allocation of Commodities.
How to get Commodities exposure?
Commodities have a physical dimension, and having direct ownership of a tanker of crude oil or a herd of live cattle is challenging and impractical.
For this reason, most investors tend to get commodity long exposure by investing in commodities-related stocks, derivatives, ETFs, indices, or in other indirect ways such as trade finance.
Adding shares of companies that produce, transform, and trade Commodities is probably the least compelling option as it adds idiosyncratic risk. As an example, labour unrest in Chile would push higher the price of copper but would negatively impact the share price of mining companies.
It would also expose the portfolio to a variety of risks at a company level, such as sanction risk, potential slavery and forced labour in the supply chain, and similar unwanted risks.
On the other hand, derivatives probably offer the best approach for institutional investors interested in getting a Commodities exposure.
For example, investors would benefit from a short-term tactical allocation in individual commodity futures to leverage a temporary imbalance of supply and demand.
For a more strategic and long-term asset allocation, portfolios would probably benefit the most from commodity ETFs and commodity indices as they offer a broad and more diversified exposure.
Commodity ETFs offer liquid and cost-effective access to a broad basket of Commodities. They come in an array of options, each offering different advantages, drawbacks, and levels of risk.
The Lyxor CRB Commodities ETF
Commodity indices track a basket of Commodities and are an important barometer of broad trends in commodity markets.
Earlier versions were not investable as they were tracking spot prices. Over the years, however, commodity indices have evolved and represent an interesting option for investors wishing to gain exposure to a wide spectrum of Commodities.
As an example, the Refinitiv/CC CRB Excess Return <.TRCCRB> Index, initially introduced in 1957, tracks the futures price of 19 different energy, agriculture, metals, and livestock exchange-traded futures.
Refinitiv/CC CRB Excess Return Index. Source: Refinitiv Eikon
The index is periodically revised to reflect the evolving landscape of the Commodities market. The underlying commodity futures are organised into four groups. Energy is the group with the highest weight at 39%, followed by agriculture at 34%, metals at 20%, and livestock at 7%.
Breakdown of the Refinitiv/CC CRB Excess Return Index by main groups and underlying components
To allow for a higher exposure to specific groups of Commodities, there are also several sub-indices, including non-agriculture and non-energy versions.
Performance of the Refinitiv/CC CRB Excess Return Index and its underlying components. Source: Refinitiv Eikon, data as of 9th June 2022
An interesting and often overlooked ESG angle
Investing in a commodity index and its underlying futures presents an interesting ESG angle that is often overlooked.
Owing shares or bonds of a company that produces or transforms Commodities translates into directly financing the production or refining of that commodity. And, as at any point in time, a company's capital is finite, this capital can be directly linked to the carbon footprint of the company.
However, as only a fraction of commodity futures are physically delivered at expiry and as futures do not affect consumption or production of the underlying commodity, it has been argued that commodity futures offer a zero environmental impact exposure to Commodities.
What to watch?
Investors approaching Commodities for the first time must be aware of two megatrends that are rapidly transforming this exciting but complex asset class.
The first is a rapid digitalisation that is bringing transparency to an industry that until very recently was particularly opaque, has levelled the playing field, and is challenging the traditional competitive advantage of the big Commodities players.
The second and possibly even more significant tectonic shift is the impact of the transition from fossil fuels to renewables. This path to net-zeroemissions is radically changing the Commodities landscape well beyond the energy complex.
Having access to best-in-class research, analytics, news, and the ability to commingle different sources of data, will dramatically increase the chances of success for investors looking to diversify their portfolio and add Commodities to their strategic asset allocation.
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