Nicolas Robin of Threadneedle Investments explains where he sees commodities playing a role in investor portfolios, and addresses certain misconceptions about this asset class.

Date: Apr 2012

Tags: Commodities, Gold, Mutual funds, Asset allocation, Portfolio construction, Diversification, Hedging

• Commodities provide diversification, as well as protection against inflation and the debasement of currencies
• A diversified exposure to commodities – for example through an index or a diversified product – is important because investors need to hedge different risks at the same time
• A key misconception in the commodities space is that these markets are more volatile than others such as equities

When looking at why investors should include commodities within their portfolios, Nicolas Robin pointed to diversification, as well as protection against inflation and the debasement of currencies – each of which plays out either in combination or separately.

While there has been some reduction in the fear of inflation in recent months, he added that it still makes sense to have some exposure if policies lead to unforeseen inflation events, in especially in the dollar based economies.

Using commodities for specific objectives

According to Robin, risk has typically been hedged using either energy or gold, which he said is a continuing trend.

Metals are a more effective way of hedging inflationary fears, he added, because they are probably more linked to the economy and to currencies, given that over time the correlation is generally stronger.

As a result, Robin said a diversified exposure to commodities – for example through an index or a diversified product – is important because investors need to hedge all the different risks at the same time.

In terms of grains and other agricultural products, he said these give a diversifier that can grow in terms of exposure.

Misconceptions around commodities

Robin said a key misconception he witnesses in the commodities space is that these markets are more volatile than others.

The reality, however, when looking at average volatility over a time horizon of 20 to 30 years, for example, is that the volatility of commodities markets is very similar to that of equities.

An active strategy

Robin said investors have generally been heavily exposed to gold or other single commodity products, or to structured notes or ETFs on oil, for example. Yet he doesn’t think these are diversified enough to give investors the broad-based exposure they need.

As a result, a fund product tends to be a better way to access this asset class.

In addition, there can be a concern with a product such as an ETF over the fact that it is a passive product. For example, there is the ability in the active space to reduce the cost of carry, which has been a bit of a concern in oil-based products over the last few years.

Active funds can also capture trends and opportunities in general overall, said Robin.