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As investors seek to generate returns, they are confronted with volatility in their equity and fixed income allocations that can potentially lead to large drawdowns.
Making matters worse, those returns have become more correlated in recent years.
A proven approach to solving this is to seek returns that are uncorrelated with stocks and bonds through various alternative investments.
Commodities can be a part of that tool kit. Their returns are largely uncorrelated with equities and fixed income, and a long/short approach can enhance those returns while mitigating volatility. Such an allocation has the potential to improve the overall outcome for an investor’s total portfolio.
In short, a commodities allocation can transform the risk and return characteristics of investor portfolios.
Commodities are essential resources that touch every facet of our daily lives, fueling industries and driving economic growth.
Yet, they are a relatively underinvested institutional asset class, due to their historic high volatility and modest long-term returns, despite having a global market size of more than $20 trillion.
By 2025, the commodities market is estimated to grow to approximately $24 trillion, and yet comparatively, only approximately 1% of institutional assets are invested in commodities.
Source: SIFMA Research, 3Q 2023; Visual Capitalist, 12/22; Prequin2021; Bank of Intl. Settlements/WSJ 2023; ZipD
Individual commodities experience wide price swings over varying time periods, driven by supply and demand imbalances, geopolitics, climate, and speculation, coupled with price reversion toward fair value. Prices are in constant flux, moving away from fair value when influenced by disruptive events and toward fair value as those events recede.
The short-, medium- and long-term volatility trends within commodities markets provides the opportunity to capture returns with a long/short strategy, while still harnessing the risk benefit from the uncorrelated nature of those returns.
