Investors have picked up commodity exchange traded funds as an alternative asset with lower correlations to their portfolios, but commodities may no longer offer the same diversification benefits as before.
“In prior years, this asset class served as a diversifier in our portfolio, given its negative correlation to publicly traded equity and significant market inefficiencies,” Harvard University Endowment said in an annual report. “In recent years, we have seen publicly traded commodities become more correlated to emerging markets equity and more populated with speculative investors. As a result, we now consider this area less valuable as a method of diversification.”
Consequently, the endowment has cut its commodities exposure of its target portfolio to zero from 8% in 2008, reports Gregory Meyer for Financial Times.
Investors have been steadily pulling out of commodities. For instance, passive investors dumped $50 billion from commodities in 2013 and another $28 billion in 2014, according to Citigroup data. Year-to-date, the PowerShares DB Commodity Index Tracking Fund (NYSEArca: DBC), the largest broad commodity-related ETF, experienced $791.1 million in outflows, according to ETF.com. [Commodity ETFs May Have More Room To Fall]
However, oil funds, like the United States Oil Fund (NYSEArca: USO), have been seeing large inflows as investors try to catch a falling knife after the steep plunge in energy prices [Don’t Frown, Average Down: Investors Still Chasing Oil ETFs]
Traditionally, commodities have been used to generate uncorrelated returns to traditional assets like stocks and bonds while keeping up with inflation. However, commodities have been weakening along with slower growth in the emerging markets, notably China – Citi argues that no emerging market will likely rise up to fill the decline in demand from China. Inflation is not a pressing matter in developed economies where many central banks are fighting against deflationary pressures. The recent surge in the U.S. dollar has weighed on USD-denominated commodities.