Commodities have long been viewed as the poor cousin in the investment universe, and often for good reason. Unlike equities, commodities do not offer a so-called market beta that drifts higher over time in line with economic activity. In contrast, they present a collection of unique price returns that reflect the underlying supply and demand dynamics of physical assets that serve as the building blocks of the global economy.
In this paper, we take a new look at commodities as an asset class and at its uses in a portfolio, which historically have been diversification and inflation protection. We also analyze different commodity beta allocations. Finally, we identify alternative investment uses of commodities, including as building blocks to express particular investment themes, as tactical trading tools, and as a component of a multi-asset risk premia allocation.
COMMODITIES AS AN ASSET CLASS
What does it mean to say commodities are an asset class? What are they, and how have they performed as an investment instrument? What are the common criticisms and misunderstandings when it comes to these distinctive assets?
Commodities have unique characteristics; they are:
- Basic, standardized physical assets that are in demand and can be supplied without substantial product differentiation across markets;
- Fungible, or in other words, considered equivalent for trading purposes despite coming from different producers; and
- Widely used production inputs in the economy.
Even though individual commodities share these important characteristics, commodities are not homogeneous. The concept of a broad commodity market beta is tenuous, likely a construct of those who championed the financialization of commodity markets more than 30 years ago. Low intracommodity correlation is one of the few common threads between individual commodity markets, though there are important exceptions among commodities that form part of the same production process or may be substitutes. There is little market “beta” when it comes to corn, copper, crude oil, and coffee.