Commodities and a Diversified Portfolio
As global commodity prices continue to linger in a protracted slump, investors in these hard assets have seen disappointing returns for several years. From the bottom of the Global Financial Crisis in March of 2009, $1 invested in the S&P 500 Index would now be worth almost $4, while investors in the S&P GSCI index of commodities would have lost roughly one-third of their money over this eight-year period. With only modest growth in global demand for raw materials in recent years and no obvious signs of a rapid surge in economic growth on the horizon, some investors are questioning whether commodities still serve a role in their portfolio.
We believe they do, and this paper will set forth our rationale for maintaining a modest strategic allocation to this distinct asset class within a diversified portfolio.
Different Asset Classes, Different Roles
When structuring a diversified portfolio, we can think of three fundamental roles a given investment or asset class may play:
1. Increase expected returns above a low-risk or “risk-free” baseline. Equities are the classic example of this, as they are highly volatile but have historically offered a significant return premium over safer investments such as Treasuries.
2. Provide stability and liquidity for an investor’s spending or other goals. Traditionally, cash and bonds serve this role – offering lower returns than stocks but with the benefit of less volatility, which is important particularly if being drawn on to meet periodic liquidity needs.
3. Diversify the portfolio. Some “alternative” asset classes, while just as volatile as equities, are not correlated with the price movements of the rest of the portfolio. By moving independently (sometimes in the opposite direction) of other elements of the portfolio, these assets can help reduce overall portfolio risk. This, in our view, is where commodities fit.