Commodities Can Provide Diversification to Portfolios | ETF Trends

VettaFi recently spoke with Jake Hanley, senior portfolio strategist at Teucrium, about how advisors can use commodities in client portfolios and how they should approach the asset class.

Teucrium is hosting a webinar, “Commodities Corner: How to Protect Your Clients and Grow Your Business,” on July 26 at 2:00 PM ET.

VettaFi: What does an allocation to commodities bring to a portfolio?

Hanley: In response to recent market instability, many advisors are turning to liquid alternatives like commodities. Commodities have the potential to provide a counterbalance, often performing well when stocks and bonds falter. For instance, the Bloomberg Commodity Index posted nearly 14% positive returns in 2022, when both stocks and bonds indices were down double digits.

Investment Vehicles for Commodities

VettaFi: What’s the best way to gain exposure to the asset class?

Hanley: There are multiple ways to obtain exposure to commodities. Some sophisticated investors will buy commodity futures contracts outright through an exchange like the CME Chicago Mercantile Exchange. Others may prefer mutual funds or exchange traded funds to obtain their exposure.

Investment advisors who are just getting started in this space often gravitate toward broad commodities strategies that are passive or actively managed. We’ve encountered a lot of investors who are in commodities but are overweight energy and precious metals because those are the two sectors in the commodity complex with which people are most familiar.

The opportunity, however, is to take a moment to consider diversifying your commodity sleeve and understand why you may be overweight or underweight a specific sector. Our firm sponsors multiple agricultural-based ETFs, and agriculture is typically a underweighted exposure in a commodity portfolio, and often for no other reason than investors just never thought to consider the space.

Handling Volatility

VettaFi: Commodities can be volatile. How should advisors view or approach commodities markets?

Hanley: There’s a bit of a misconception around the extent of volatility in commodities. Take the BCOM index again, for example, and if you look at 30 years’ performance data going back to 1992 through 2022, the S&P Total Return Index and BCOM had roughly the same standard deviation. (Actually, the S&P 500 Total Return Index has a little bit higher standard deviation at 17.78% versus BCOM at 17.09%).

What’s really interesting is that the S&P 500 Total Return Index’s average return over those 30 years was about 9.6%, and the BCOM average return was less than 1% over the same time frame. With BCOM you’re taking just about the same amount of risk, but you’re getting substantially lower returns. Herein lies the opportunity.

Reasonable Performance Goals

A lot of investment advisors spend their time trying to outperform the S&P 500 [by taking an active approach to stock allocation], so they’re trying to outperform an average rate of return over the last 30 years of nearly 10%! That’s a tall order.

What if you took that same time and energy [to the commodities space]and tried to outperform the BCOM index where your hurdle is less than 1% on average per year? To me, it seems more likely that you may be able to outperform a broad commodity index than you are to outperform the S&P 500.

But again, in the context of the overall portfolio, incorporating commodities may help improve a portfolio’s risk-adjusted return over time. The first step is deciding to obtain exposure to commodity prices, and the second step is to create a strategy within the commodity sleeve that provides an opportunity to improve your clients’ outcomes in commodities.

VettaFi: How granular should a commodities investor get? What kind of strategies should they be using?

Hanley: It’s going to be different for every investor, depending on their approach to portfolio management. Overall and as an investment advisor, you have to consider your own time and talent and incorporate an approach that not only has a high probability of improving your clients’ outcome in the commodity space but is also sustainable for you as an investment manager. If you want to be more tactical and invest in single-commodity strategies, those are available to you through firms like ours. However, if you’d like to take a more strategic approach and are looking to drill down to specific commodity sectors but not individual commodities, then there are diversified sector funds such as the ones that we offer in the agriculture and base metals markets.

Client Messaging

VettaFi: What kind of messaging should advisors be passing on to their clients around the commodities asset class?

Hanley: Advisors have come to us because their clients are asking them for exposure into commodities. It’s important to be prepared for those times when the client initiates the conversation. A big part of my role as senior portfolio strategist is to help investment advisors have those conversations with clients. In that role, I first need to understand how an investment advisor approaches portfolio allocation. Once I understand the investment advisor’s approach, then I can help craft the messaging as to how commodities, in general — or a specific strategy — may be complementary to an existing portfolio and potentially enhance their clients’ outcomes.

For more news, information, and analysis, visit the Commodities Channel.