Surging oil prices following Russia’s invasion of Ukraine in late February sparked broad-based stock sell-offs around the world. Investors reacted immediately, concerned that limited energy supplies and higher costs could exacerbate inflation, then jumped back into stocks just as quickly when oil prices began ticking down, FlexShares wrote in a recent insight.
Volatility driven by short-term swings in oil prices has continued since the start of the conflict, demonstrating the impact of oil prices on investment portfolios; however, investors with more direct exposure to energy-related sectors through commodities and infrastructure strategies likely have experienced a smoother ride.
Recent performance by natural resources and infrastructure investments, including the FlexShares Morningstar Global Upstream Natural Resources Index Fund (GUNR) and the FlexShares STOXX Global Broad Infrastructure Index Fund (NFRA), have illustrated the important role these strategies can play in a diversified portfolio.
Infrastructure strategies can provide protection in volatile markets because their returns typically aren’t directly connected to the prices of those commodities, according to FlexShares. That’s why infrastructure funds often serve as defensive strategies in a portfolio.
Although they include investments related to the oil and gas industries, oil and gas pipelines are paid based on the volume of product moving through their networks, regardless of commodity prices. Utilities that face higher prices for the fuels they use to generate electricity generally are allowed to pass those costs onto their rate payers, keeping their cash flow more predictable in volatile energy markets, according to FlexShares.
Investors largely add real asset exposure to their portfolios to act as a hedge against inflation. Unlike infrastructure, companies directly involved in extracting commodities like oil and gas from the ground — as well as agricultural products, metals, timber, and water — should benefit when the price of these economic building blocks rises dramatically, according to FlexShares.
A commodities strategy heavily concentrated in oil and gas producers that may have delivered higher returns during February and March of 2022 is subject to higher risk of losses when demand for energy declines. A well-diversified natural resources strategy that includes exposure to other important sectors can provide the inflation hedging and return potential that investors seek, without taking additional risks related to an energy sector that’s still in the midst of a long-term transition, according to FlexShares.
Likewise, infrastructure strategies should balance investments across sectors to avoid concentration in energy-related industries like pipelines and utilities, according to FlexShares. Geographic diversification can also reduce risks related to regulations, political activity, and natural disasters.
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