INVESTMENT STRATEGIES COMMODITIES
Finding the right approach
Despite the hammering that commodity funds have taken recently, commodities as
a long-term theme still has its vocal supporters. The question now is whether to play
the theme through a unit trust, structured product or exchange-traded fund
BY ROB GRIFFIN
SUMMARY
Commodities are still a popular
investment theme despite
funds taking a beating over
the past few months.
A positive, given the current
market conditions, is their
negative correlation with
equities and bonds and
positive correlation with
inflation measures.
Far from ignoring
commodities, investors need
to consider how to access the
theme – through ETFs, unit
trusts or structured products.
Talk to most investment
managers about the performance
of commodities
and the discussion
will invariably be divided
into two parts: the soaring
values during the halcyon
months leading up to July,
and the dark days since.
To say the sector has
been unpredictable of late
would be a big understatement.
Even given the often
volatile nature of its constituent
parts – particularly
oil and food – the events
of the past few months
have been extraordinary.
l Chaos reigns
Four of the strongest years
of growth in living memory
have given way to widespread
fears about a global
slowdown – and this has
had a major impact, according
to Richard Batty, global
investment strategist at
Standard Life Investments.
Add in the fact that the
dollar has been yo-yoing
and stock markets around
the world have been going
into a collective meltdown
over the problems suffered
by a string of corporate
giants, and it all makes for
a pretty heady mix.
“Investors have noticed
these events and have really
changed their mind about
the prospects since July,”
says Batty. “Commodities
are likely to remain under
pressure as evidence comes
through that the world
economy is slowing.”
But that does not mean
they should be ignored,
insists Andy Gadd, head
of research at Lighthouse
Group. They have historically
demonstrated returns
that are negatively correlated
with equities and bonds,
but positively correlated
with inflation measures.
“These characteristics
imply that an allocation
to a range of commodities
in a diversified equity and
bond fund can improve
the risk and return characteristics
of the overall
portfolio,” he says.
Given what has taken
place in recent months,
there is little wonder that
advisers are questioning
how clients should play
commodities – and whether
now is really the right
time to get involved.
l Finding an entry
Essentially, there are three
ways in which investors
can access the sector:
through an investment
fund, via some form of
structured product or with
an exchange-traded fund
(ETF).
An investment fund may
directly hold the underlying
commodities but is far
more likely to invest in
the shares of companies
actually involved in one
or more of the commodity
sub-sectors.
The structured product,
meanwhile, will be an
investment note designed
to run for a fixed period
and generate a return
based on one or more
of the commodity indices
– depending on the investment
house offering it.
24 PORTFOLIO ADVISER [www.portfolio-adviser.com] DECEMBER 2008
Commodity funds vs index – 10-yr p’mnce
150
%
100
300
250
200
50
0
-50
’98 ’99 ’00 ’01 ’02 ’03 ’04 ’05
1 Nov ’98 – 1 Nov ’08. Source: Morningstar
Although ETFs can be
linked to a specific commodity
index, products
are increasingly becoming
available linked to the
actual physical commodities
themselves.
Which option is most
suitable for clients will
depend on factors such
as their individual aims,
their attitude to risk, their
investment time horizons
and how the rest of their
investment portfolio is
constructed.
For example, those
investors who take a longterm
view and are not too
fazed by volatility could
find a straightforward unit
trust will meet their needs,
suggests Geoff Penrice, a
senior adviser with Bates
Investment Services.
“A combination of the
increasing industrialisation
of developing economies
and limited resources
means commodities are a
good long-term bet,” he
says. “It is harder to predict
the short and medium-term
direction of prices.”
Commodity & natural resources funds
The erratic performance
of natural resources funds
over the past couple of
years illustrates his point.
Take the JPM Natural
Resources Fund. In
the three years to mid-
September it has delivered
a solid bid-to-bid return of
42.1%, although the past
year to the same date has
seen the fund lose a staggering
22.9%, while over
the three months to early
November it fell by 50%.
l Risk factor
Ryan Rogowski, head of
structured products at
Harewood Solutions, points
out that there is another
important point for advisers
to consider: unit trusts
mean clients are taking on
equity risk.
“Many funds only give
exposure to commodity
stocks and not commodities
themselves, so investors do
not typically benefit from
the low correlation that
direct commodity investments
can bring to a port-
MSCI World
’06
’07
’08
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