Investing in commodities – good for diversifying a portfolio?

Commodities are types of raw materials or products needed to produce food, energy, clothing and much more. They play a crucial role in an economy and are typically split into two broad categories – hard and soft.

Hard commodities are materials that must be mined or extracted from the earth. They include oil and gas, industrial metals like steel and copper, precious metals like gold and silver, and other materials like rubber. Soft commodities are mostly agricultural products that are grown or reared, like wheat, coffee or livestock.

At times, it can be difficult to invest directly in certain commodities, and they can be hard to understand or value. But there are lots of ways to do it. And it could offer some interesting opportunities for investors.

Like all assets though, commodity prices are ultimately determined by supply and demand. A strong economy might lead to increased demand for oil and other energy commodities for example. The supply and demand for commodities can also be impacted in other ways, like economic shocks or natural disasters.

This isn’t personal advice. If you’re not sure what’s right for your circumstances, ask for financial advice. Remember all investments can fall as well as rise in value, so you could get back less than you invest.

What role can they play in a portfolio?

Commodities can offer three main benefits to investors – some inflation protection, potential for returns and diversification to a broader investment portfolio.

Diversification is one of the main reasons for investing in commodities. They can react differently to the more traditional investments like shares or bonds. This means they have the potential to perform differently too. For example, when stock markets go down, commodities might rise in value. But the reverse is also true, and this type of performance isn’t guaranteed.

Commodity prices might also rise when inflation increases. When the demand for goods and services rises, prices increase, and any commodities used usually follow suit. As a result, investors might look to certain commodities when inflation rises to help offer some shelter.

What are the risks?

While investing in commodities offer a number of potential benefits, they also come with their risks. Values are based on supply and demand, both of which can change quickly, so prices can be volatile. Soft commodities are also exposed to a host of other risks like adverse weather, natural disasters or even diseases.

There have been times when commodity-related investments have gone through prolonged periods of weaker performance. And their performance can sometimes come in fits and bursts. A good example is the oil & gas sector.

In 2014 the price of Brent Crude Oil was over $110 a barrel. But between mid-2014 to the early part of 2016, the price collapsed by 70%, driven largely by an oversupply. The price slowly increased over the next three years and just as the pandemic took hold in March 2020, the price per barrel collapsed again to lows not seen in 20 years. In a matter of months, the price started to recover and ended up surpassing $120 per barrel at points during 2022.

Specialist sectors like oil & gas can be volatile, with investments falling and rising very quickly. Investors need to be aware of this and only invest if they’re prepared to take a long-term view.

This is a specialist area and naturally comes with more risk. Investors should consider these risks, and think about how alternative assets can, or should, form a part of their portfolio. For investors considering commodities, we think it should only form a small part of a diversified portfolio. All investments, including commodities, rise and fall in value, so you could get back less than you invest.

How have they performed?

Inflation has been gradually increasing since the early part of 2021, and supply-side challenges have put pressure on the recovery of the economy. We’ve seen an increase in the cost of living, mainly through a surge in utility and food prices.

The tragic situation in Ukraine since February this year has also exacerbated these issues. There have been rapid developments on military, political, economic and humanitarian levels, and the crisis has shocked commodity markets.

The price of Brent Crude Oil surpassed $120 a barrel at points this year, driven largely by the war-related trade and production disruptions. It was also impacted by the price increase announcement by Saudi Arabia. Russia and Ukraine are significant players in the production and distribution of soft commodities, so wheat, maize, corn, soybeans, and palm oil have also surged.

While prices might look strong, and some investors will have benefitted from this, there are concerns things could get worse. For example, the Russian invasion could end up worsening existing food shortages, pushing prices higher, to perhaps unsustainable levels. Adverse weather conditions in South America and labour shortages in parts of Asia could also further restrict already limited supplies.

The current market turbulence and uncertainty is reaching critical levels. High inflation rates have renewed interest in adding commodities to try to hedge against inflation and increase portfolio diversification. But there are plenty of risks that come with investing in this space.

How to invest in commodities

Purchasing physical commodities – a barrel of oil, a herd of cattle or a bushel of wheat – is impractical for most. But there are other options.

You can get indirect exposure to the commodity market by buying and selling the shares of companies involved in the mining, extraction, growth or harvesting of any type of commodity. Though they might not offer the same diversification as the commodity itself.

Exchange-traded funds (ETFs) are a simple and convenient way to invest in commodities. They’re bought and sold the same way as shares, and aim to track the performance of the entire market for a commodity.

Some ETFs invest in the physical commodity, and the manager is responsible for transportation, insurance and storage costs. Others use derivative contracts to artificially replicate the performance of the commodity, without having to own it. This saves on costs, but it’s a higher-risk approach.

Fund ideas to invest in commodities

Funds are another easy way to invest. Here’s a closer look at three fund ideas to invest in commodities.

Investing in funds isn’t right for everyone. An investment in a specialist area adds risk, so should only form a small part of a well-diversified portfolio.

Investors should only invest if the fund’s objectives are aligned with their own and there’s a specific need for the type of investment being made. These investment ideas aren’t personal advice, if you’re not sure if an investment is right for you, seek advice.

BlackRock Global World Energy

The BlackRock Global World Energy fund invests in shares of companies whose main business is in the exploration, development, production and distribution of energy. It mainly invests in the US and Canada, but also invests across Europe, including the UK, France and Spain.

The co-managers, Alistair Bishop and Mark Hume, have been managing the fund since September 2017. Hume has spent a large portion of his career analysing energy stocks, whereas Bishop’s expertise lies in clean technology and renewable energy.

The fund is concentrated, which means each investment can contribute significantly to overall returns, which can increase risk.

Annual percentage growth

Past performance is not a guide to the future. Source: Lipper IM, to 30/06/2022.

FIND OUT MORE ABOUT BLACKROCK GLOBAL WORLD ENERGY INCLUDING CHARGES

VIEW BLACKROCK GLOBAL WORLD ENERGY KEY INVESTOR INFORMATION

JPMorgan Natural Resources

The JPMorgan Natural Resources fund aims to grow investors money over the long term by investing in companies around the world engaged in the exploration, development, refinement, production or marketing of natural resources.

It’s mainly invested in the US, UK and parts of Europe, but also invests in certain emerging markets, which adds risk. The fund also invests in a variety of sectors, including mining, oil & gas, metals and exploration & production.

Christopher Korpan has been managing the fund since February 2017 and has been supported by co-manager Veronika Lysogorskaya for over two years.

The fund is concentrated, which means each investment can contribute significantly to overall returns, but the reverse is also true which adds risk. The managers also have the ability to invest in higher-risk smaller companies.

Annual percentage growth

Past performance is not a guide to the future. Source: Lipper IM, to 30/06/2022.

FIND OUT MORE ABOUT JPMORGAN NATURAL RESOURCES INCLUDING CHARGES

VIEW JPMORGAN NATURAL RESOURCES KEY INVESTOR INFORMATION

Barings Global Agriculture

Barings Global Agriculture aims to grow investors money by investing across the agricultural value chain, from harvesting crops to having the food delivered to our tables. The fund invests across the globe. It mainly focuses on companies in the US, but it also includes investments in parts of Europe, Asia, and some higher risk emerging markets.

James Govan, Clive Burstow and Piers Aldred are all named co-managers on the fund and have over 50 years’ of combined industry experience.

They aim to identify companies offering growth at a reasonable price. In other words those with the potential to grow profits in the future, but without the expensive share price tag. This includes companies like agricultural manufacturer Deere & Company, speciality chemical provider Koninklijke DSM and Norwegian based salmon breeder, Bakkafrost. The managers also have the flexibility to use derivatives which can magnify any gains or losses.

While the fund contains a diverse range of investments within the agricultural space, it is concentrated. This approach means each investment can contribute significantly to overall returns, but it can increase risk. The managers also have the ability to invest in higher-risk smaller companies.

Annual percentage growth

Past performance is not a guide to the future. Source: Lipper IM, to 30/06/2022.

FIND OUT MORE ABOUT BARINGS GLOBAL AGRICULTURE INCLUDING CHARGES

VIEW BARINGS GLOBAL AGRICULTURE KEY INVESTOR INFORMATION

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