Four Arguments for Investing in Commodities

It is always Darkest Before the Dawn: Four Arguments for Investing in Commodities

[box]In this paper, Parametric Head of Investment Strategy Tim Atwill makes the case that, despite recent returns, a strategic allocation to the commodity asset class still makes sense on a forward-looking basis, given its desirable combination of inflation protection and low correlation with the equity and fixed-income asset classes.[/box]

The commodity asset class has become a pariah to most investors, the victim of a 5-year swan dive, with cumulative losses totaling over 50%, as measured by the Bloomberg Commodity Index. Despite recent returns, we maintain that a strategic allocation to the commodity asset class still makes sense on a forward-looking basis, given its desirable combination of inflation protection and low correlation with the equity and fixed-income asset classes.

The recent poor performance in commodities raises the question of why any such allocation should even exist, given that over the last five years commodities have dropped, while both equities and bonds have risen. This argument ignores the fact that diversification is a tool for dealing with an unknown future, and always looks somewhat damaging in retrospect. Given asset class returns remain devilishly difficult to predict consistently, we believe diversification still provides the only free lunch in investing.

In this paper, we present four arguments that provide strong evidence for why investors who have stuck with the asset class should remain invested and why everyone else should consider the current environment as an opportunity to add commodity exposure to their portfolios. However, we note that while the observations below are somewhat tactical in nature, the strongest arguments for including commodities in a portfolio are for their strategic roles as a diversifying asset class and as a hedge against inflation.

Conclusion

Commodities have become one of the most shunned asset classes over the past five years, as the recent bear market has been notable for both its length and magnitude. This decline has caused many investors to either exit, or reduce their strategic allocation to commodities. In this brief we have laid out supporting arguments that should assist in motivating an investment in commodities. They remain a powerful diversifier to an investor’s portfolio; recently observed increases in CPI make its inflation-protection properties appealing; recent returns for the asset class have been diminished by currency impacts, which are unlikely to be repeated; and the size and severity of the last downturn may predicate a sharp recovery when it occurs. Investors should look past recent returns and, instead, make a decision based on the future potential of this asset class.

Parametric is a Eaton Vance company with $160 billion in assets under management.

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