Raw materials as an alternative investment in a diversified portfolio
The use of commodities in a traditional portfolio
What are raw materials and what do we mean by this
Commodities are seen as the black sheep of the investment world, and often for good reason. Unlike stocks, commodities do not have a market beta that becomes increasingly productive and increases as time goes by. The prices of raw materials reflect the underlying supply and demand of these physical assets. When we talk about raw materials, we of course mean a broadly diversified ETF with all kinds of raw materials in it.
Commodities as an investment category
Although raw materials individually have the same properties, they are often poorly correlated. It happens that they have the same production processes, but there is little market beta when it comes to corn, copper, oil and coffee., (volatility). For example, if the price of oil suddenly rises, coffee may simply remain stable. This is different from the stock market, where you run the risk that it will collapse as a whole, but you will not actually have this risk with commodities.
If you look from 1970 to 2021 you will see that the price of commodities has only risen slightly, although they occasionally have periods of big jumps in price. Because they have not performed very well as an individual asset class, this does not mean that they could not fit well in a well-diversified portfolio.
Use of raw materials – Protection against inflation
One of the most common justifications for including commodities in your long-term portfolio is that commodities have historically been a good hedge against inflation. They are especially effective when there is unexpectedly high inflation like we have had in 2021. This makes sense because it is usually a sudden change in the supply of the specific commodity that causes unexpected inflation.
You can now see this clearly. Now that there are problems with the supply of gas/oil, you see that the price immediately shoots up, and we see that petrol prices of €2.30 per liter are starting to become normal. Even though real asset inflation is likely lower today than it was in the past, due to changes in consumption, productivity and technology. Starting from today’s inflation level, a little bit of inflation can mean a big change in the price of a commodity.
For many investors, it has been a long time since there was a period when inflation was sky-high. Inflation has shot through the roof recently, and we are looking at an inflation rate of 7.5% in 2021. This means that if you had invested €10,000 in January 2021, you would only have had approximately €9,250 left on January 1, 2022. Investors often have a short memory, and therefore seem to find it difficult to build a portfolio that can withstand periods of high inflation.
Raw materials for better distribution
Spread is the only ‘Free Lunch‘ when investing. Combining asset classes that have low correlations can help reduce volatility WITHOUT sacrificing potential gains. In other words, adding commodities to your portfolio can give you the same returns with less risk, thus improving your risk-return ratio. Commodities tend to have a low correlation with traditional categories such as bonds or equities. And they can deliver value in terms of distribution. Especially if you also hold gold in your portfolio in addition to raw materials, you can protect yourself well against blows in the market.
Commodities ETF, commodity index
Because it is difficult to physically store raw materials, you always have to deal with a non-physical ETF. Normally we always opt for a physical ETF because of the risk, but this is not possible with raw materials, because it becomes difficult to store a corn cob for 15 years. Presumably it won’t be worth much after 15 years in the closet. It would be difficult and expensive for investors to physically store, buy and sell live cattle and barrels of oil as investments. Bloomberg Commodity Index has become the benchmark for commodities in general. We look for an ETF that tracks one of these indexes cheaply and add it to our portfolio. One like the “iShares Diversified Commodity Swap UCITS ETF”.
If you look at raw materials for the long term, it is important to look at the possible returns. Below you see an example in which raw materials have been added to a 60/40 portfolio. A portfolio with a small percentage of raw materials has performed less than a portfolio without raw materials. Commodities have clearly ensured that there is less volatility, especially when things are really going wrong. Out this extensive research on adding broad commodityy’s The conclusion that a long-term investment strategy can improve returns and reduce risks.
If you look at the risk-reward ratio, the question was whether adding commodities would have been worth it. Lower volatility has also recently been accompanied by lower returns. The question is whether this will remain the case or whether it may still be wise to retain a small percentage of raw materials. I personally opt for the latter case and currently hold 7.5% of my total portfolio.
Crude Oil Copper Gold
Sugar
Live Cattle Natural Gas Soybeans Aluminum Silver Coffee Lean Hogs Crude Oil Soybean
8.04% 5.40% 15.00% 2.79% 3.58% 7.95% 5.79% 4.25% 4.75% 2.73% 1.75% 6.96% 3.52%
Zinc
Cotton
Gas Oil Wheat Nickel Gasoline Soybean Oil Diesel
Conclusion
No one has a
are advantages to diversifying with raw materials. Personally, I think that a portfolio with a good diversification cannot do without raw materials.
Commodities can offer a solution in the area of protection against inflation and times of misery. Choosing a good diversification is the most important choice you can make as a long-term investor, and is the only one over which you have 100% complete control. By adding some raw materials to your portfolio, you can reduce volatility without having to sacrifice returns. It may therefore be wise to consider commodities for your investment portfolio.
3.19% 1.50% 2.65% 2.84% 2.71% 2.17% 3.17% 2.05%
crystal ball or can see into the future, but the long history shows that there
