As a way to compliment a traditional portfolio mix of equities and fixed-income assets, exchange traded fund investors should consider the diversification benefits of holding some exposure to alternative assets, like commodities.
“Commodities are key alternative investments that may offer diversification benefits for portfolio allocations through low correlations to other asset classes and its own sub-sectors,” Maxwell Gold, Director of Investment Strategy at ETF Securities, said in a research note.
Investors should not overlook commodities as a critical component for a strategic, long-term portfolio component, especially in the current global landscape of evolving monetary policy, geopolitics and demographics, according to Gold.
Basic fundamental factors of supply and demand typically drive the commodities market, and this scarcity in addition, along with other factors like geopolitics and weather, tend to track global macroeconomic conditions closely. Moreover, many commodities are critical inputs for products and services we consume daily, which also make them highly sensitive to cyclical trends and inflationary trends.
More importantly, investors would enjoy the diversification benefits of commodities as the asset exhibit low correlation to traditional stocks and bonds.
“This low correlation stems from the fact that commodities are global assets driven by varying fundamentals,” Gold said. “These distinct drivers lead to exposures beyond those factors offered from traditional financial assets like stocks and bonds.”
When looking at three major commodity indices, the average 3-year correlation to a fixed 60% stock and 40% bond allocation is approximately 0.2 since 1979 – a zero reading would indicate zero correlation and a 1 reading would indicate perfect correlation.