Vasu Menon of OCBC Bank explains his views on commodities and looks at how investors can access the different types as a part of their portfolio.
Date: Oct 2011
Hard commodities, for example, such as copper, zinc and aluminum, is a play into emerging markets in Asia, because the growth for these commodities will be driven out of infrastructure development linked to China, India and other markets, he explained.
While the market will see a lot of volatility and pull-back in the short term, with governments in these emerging markets building up their infrastructure in the medium to long term, Menon predicted there will be demand for base metals.
In terms of soft commodities, the weather patterns around the world have led to a dearth in supply at the same time as there is greater demand, said Menon, for instance with the greater consumption of meat in line with rising affluence.
According to Menon, with the US dollar headed for further weaknesses, this augurs well for gold.
The other factors positive for gold are that as central banks across the world are starting to diversify foreign reserves away from US dollars and towards other asset classes, at the margin they are buying gold, he explained.
At the same time, individuals in Asia and elsewhere in the world are starting to recognise gold as a distinct asset class.
Commodities within portfolios
Another hurdle is that a lot of investors aren’t sure how to invest in the commodities space, given that this is a relatively new asset class, he said, adding that there is also a risk that many investors get carried away and over-invest in the asset class, just as they did with the technology sector around the turn of the century.
Menon said he wants people to invest in commodities – which they can do via ETFs, mutual funds and commodity-related companies listed on the exchanges – but investors should be aware that values can fluctuate over time.
Investors should not look to hold more than about a 5% to 10% allocation to commodities in their portfolios, he advised. It is mainly for people with a higher risk appetite, and they should manage risks by making sure they don’t over-invest.
Considerations when buying commodities
Investors who are skeptical about the ability of fund managers to deliver returns should look at ETFs for their commodities exposure, said Menon.
For those investors who believe fund managers can add value, they need to research the performance of the managers, assess the depth of the investment team, understand how they do their research, and see if they are able to generate alpha, he explained.
Investors also need to be aware that some commodity funds invest in derivatives that are related to commodities, some invest in ETFs related to commodities, and others invest in commodities companies directly.
However, with commodities companies there is an additional layer of risk, said Menon, because rather than just investing in the underlying commodity, this is also an investment into the quality of the management.