Head of CommoditiesMore by this author
Senior Portfolio SpecialistMore by this author
17 minute read
Commodities have delivered historically strong performance, providing inflation hedging, diversification and compelling returns, with the potential to contribute meaningfully to a real assets allocation.
- Commodities historically have provided an effective hedge against inflation and event risk.
- With sectors including energy, agriculture and industrial metals, the asset class offers meaningful portfolio diversification potential.
- Commodities may offer attractive total returns, propelled by a favorable macroeconomic environment and attractive supply/demand fundamentals.
The Russian invasion of Ukraine has thrown a spotlight on commodities as virtually every sector—from energy to agriculture to metals—has surged on supply concerns stemming from the war.
The longer the war continues, the higher the likelihood that supply disruptions will persist, with the possibility of lasting shifts in trade flows that could reshape commodity markets for years. While direct sanctions have been limited thus far, port closures, self-imposed embargoes and trade financing obstacles have directly affected the flow of commodities from the region, impacting spot markets.
As a result of the war, tail risks are skewed to the upside for commodities produced in the Black Sea region, in our opinion. However, a pullback in commodity prices is possible. Catalysts for a pullback could include: de-escalation of the war, additional supplies of affected commodities, or a lower-than-expected ultimate impact to flows of Russian- or Ukrainian- produced commodities.
The pronounced price appreciation that commodities have experienced in the face of this geopolitical and inflationary supply shock compared with the reaction in traditional risk assets such as equities and bonds is a stark reminder of why we believe commodities should be a strategic allocation in a well-diversified real assets portfolio.
Even before geopolitical tensions reached a boiling point, commodities had delivered returns ahead of equities in this inflationary environment. We believe the reasons to hold commodities in a real assets portfolio—namely, their strong inflation-hedging characteristics, diversification potential and historical ability to produce attractive total returns over full market cycles— are as strong as ever.
We believe the reasons to hold commodities in a real assets portfolio are as strong as ever.
Commodities have historically outperformed in inflationary environments
In contrast to the slow and shallow recovery out of the global financial crisis, which was characterized by deflationary globalization forces and insufficient demand, the fast and furious recovery out of the Covid pandemic has been characterized by inflationary anti-globalization forces and insufficient supply.
Unprecedented levels of consumer savings and pent-up demand will continue to support economic growth and consumption, in our opinion. At the same time, tight labor markets and impaired supply chains are driving inflationary pressures from the supply side of the economy.
Since the second half of 2021, inflation in the United States has surprised to the upside, with the consumer price index reaching a 40-year high in early 2022, and we think a combination of strong demand and impaired supply points to persistent inflation pressures with the potential to pass through to commodity prices.
Historically, commodities have outperformed traditional asset classes such as stocks and bonds in periods of rising inflation as well as unexpected inflation (Exhibit 1). In fact, even among its real asset peers, such as resource equities, real estate and infrastructure, the historical inflation sensitivity of commodities is superior.
Why is that? Commodities such as energy, grains, softs, livestock and metals serve as direct inputs to inflation measures. Commodities, which are raw materials, also tend to respond more quickly to economic forces—such as supply constraints and changes in global demand—that often drive the prices of other goods higher.
Historically outperforming stocks and bonds
Average annual real returns in periods of…
At March 31, 2022. Source: Barclays, Bloomberg, Dow Jones, FTSE, S&P, Refinitiv Datastream, Cohen & Steers.
Past performance is no guarantee of future results. Inflation measured as the year-over-year change in the Consumer Price Index for all urban consumers, published by the U.S. Bureau of Labor Statistics. Rising inflation is measured as a positive year-over-year increase in the 12-month inflation rate. Unexpected inflation measured as a positive difference between the year-over-year realized inflation rate and lagged 1-year-ahead expected inflation, as measured by the University of Michigan survey of 1-year-ahead inflation expectations. The real assets blend is not representative of an actual portfolio and is for illustrative purposes only. The information presented above does not reflect the performance of any fund or other account managed or serviced by Cohen & Steers, and there is no guarantee that investors will experience the type of performance reflected above. See end notes for index associations, definitions and additional disclosures.
Commodities can provide meaningful portfolio diversification
In an environment of elevated inflation and rising interest rates, portfolio diversification may be more important than ever. Commodities have distinct economic sensitivities that tend to differentiate them from stocks and bonds, most notably in relation to inflation and growth periods.
And in times when geopolitical tension and potential supply shocks are high, the factors that negatively impact asset classes such as equities and bonds can positively impact commodities.
Commodities historically have had a low correlation to global stocks (0.42 from 1991 through the first quarter of 2022), adding potential diversification benefits to inflation sensitivity (Exhibit 2). In this case, the low market beta of commodities suggests significant diversification potential, helping to reduce portfolio volatility and, we believe, improve risk-adjusted returns.
Diversification potential of commodities
Beta to global equities(1) 1991-Q1 2022
At March 31, 2022. Source: Barclays, Bloomberg, Dow Jones, FTSE, S&P, Refinitiv Datastream and Cohen & Steers.
Data quoted represents past performance, which is no guarantee of future results. The information presented above does not reflect the performance of any fund or other account managed or serviced by Cohen & Steers, and there is no guarantee that investors will experience the type of performance reflected above. There is no guarantee that any historical trend illustrated above will be repeated in the future, and there is no way to predict precisely when such a trend will begin. Diversification does not ensure a profit or protect against loss. Strategies that trade in commodities involve a risk of loss. Beta measures the relative volatility of an investment as compared to a standard market index. A market index will always be equal to 1.00. An investment with a higher/lower beta, more/less than 1.00, is more/less volatile than the market index.
- Global equities represented by the MSCI World Index.
- Commodities represented by the Bloomberg Commodity Index.
- Infrastructure represented by 50% Datastream World Gas, Water, & Multi-Utilities/30% Datastream World Pipelines/20% Datastream World Railroads through December 2002 and Dow Jones Brookfield Global Infrastructure Index thereafter.
- Real estate represented by Datastream Developed Real Estate through December 1989 and FTSE EPRA/Nareit Developed Index thereafter.
- Natural resource equities represented by 50/50 blend of Datastream World Oil & Gas and Datastream World Basic Materials through May 2008 and S&P Global Natural Resources Index thereafter.
Attractive total return potential
A highly favorable macroeconomic environment for real assets generally— and commodities specifically—has unfolded quickly, at a time when supply/ demand fundamentals for commodities were already supportive.
From a fundamental perspective, inventories for many commodities were at multi-year lows at the end of 2021, leaving producers scrambling to meet a resurgence in demand when Covid lockdowns were relaxed (Exhibit 3).
However, the lack of investment in supply in recent years means that ramping up output will take time. Lingering Covid-related production issues, supply-chain constraints and elevated power costs driven by the Russia- Ukraine war only add to the low inventory situation. In sum, we believe the risk of continued supply chain disruptions and tight inventories across many sectors is high. Further evidence of fundamental support can be seen in the shape of the futures curve for many commodities. Elevated demand and tight supplies have resulted in 80% of the commodities in the Bloomberg Commodity Index in backwardation (when spot prices are higher than future prices) as of March 31, 2022.
Commodity inventories ended 2021 below their 10-year peaks
At December 31, 2021. Source: BMO, USDA, IEA, World Gold Council, S&P Global Platts, GFMS, Bank of America, UBS, CRU Group, Wood Mackenzie, Wilton Agriculture Strategies, Cohen & Steers proprietary analysis.
Data quoted represents past performance, which is no guarantee of future results. This chart is for illustrative purposes only and does not reflect information about any fund or other account managed or serviced by Cohen & Steers. There is no guarantee that any historical trend illustrated above will be repeated in the future, and there is no way to predict precisely when such a trend will begin. An investor cannot invest directly in an ind ex and index performance does not reflect the deduction of any fees, expenses or taxes. See page 8 for index definitions and additional disclosures.
Looking beyond immediate spot fundamentals, support for the asset class may come from global decarbonization. A fixed asset investment cycle linked to the green energy transition, which we believe will incrementally increase demand for many commodities over the next 10 years, is just beginning.
Combined, these fundamental economic factors should provide a solid environment for commodities to offer total returns that are competitive with global equities, as they have done over the last 50 years (Exhibit 4).
Competitive long-term total returns
March 14, 1972–March 14, 2022
As of March 31, 2022. Source: Bloomberg.
Data quoted represents past performance, which is no guarantee of future results. This chart is for illustrative purposes only and does not reflect information about any fund or other account managed or serviced by Cohen & Steers. There is no guarantee that any historical trend illustrated above will be repeated in the future, and there is no way to predict precisely when such a trend will begin. An investor cannot invest directly in an index and index performance does not reflect the deduction of any fees, expenses or taxes. See page 8 for index definitions and additional disclosures.
Poised to contribute to a multi-strategy real assets portfolio
Commodities are one of the four main asset classes typically included in a real assets allocation. The others are real estate, infrastructure and resource equities. Together, they comprise the “core four” real assets categories. Within a multi-strategy portfolio, real assets are typically employed to meet three goals:
- Deliver outperformance in inflationary periods
- Enhance risk-adjusted returns via diversification
- Maintain strong returns over full market cycles
Historically, no single real asset has excelled across each of the criteria of inflation sensitivity, diversification potential and total returns. Commodities, for example, have historically delivered the strongest results in the areas of inflation sensitivity and diversification, while real estate has historically delivered relatively consistent attractive total returns (Exhibit 5).
Three goals for real assets
Commodities typically strong contributors to inflation sensitivity, diversification
At March 31, 2022. Based on Cohen & Steers analysis and expectations.
There is no guarantee that any historical trend illustrated above will be repeated in the future, and there is no way to predict precisely when such a trend will begin. See page 8 for index definitions and additional disclosures.
While many investors allocate individually to each of the core four categories, a turnkey real assets solution that strategically and tactically invests across all four has the potential to overcome the tradeoffs of standalone real assets exposures and better capture the positive attributes of real assets.
A resurgent global inflationary environment—not seen in more than 40 years—is causing investors to take a closer look at their asset allocation. Outsized exposure to traditional risk assets such as equities and bonds, which excelled in the prior disinflationary decade, appears unlikely to provide the inflation protection, diversification and return profile that investors have grown accustomed to.
This new world order, marked by elevated inflation, rising interest rates, deglobalization, tight labor markets and heightened geopolitical risks, has driven renewed investor interest in commodities. Commodities’ high inflation beta, relatively low correlations with traditional asset classes, and attractive long-term return potential cements its critical role in a diversified real assets portfolio in our view.
While many investors continue to prefer stand alone commodities investments, more are gaining exposure to commodities via an actively managed, multi-strategy real assets portfolio, seeking the benefits of the blend in a single allocation.
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After a decade-long bear market, commodities are showing signs of life. We see further upside potential despite significant repricing from pandemic lows, driven by a supportive macro backdrop, attractive fundamentals and growing investor demand for inflation-sensitive assets.
Index Definitions / Important Disclosures
An investor cannot invest directly in an index and index performance does not reflect the deduction of any fees, expenses or taxes. Index comparisons have limitations as volatility and other characteristics may differ from a particular investment.
Real assets blend: 27.5% real estate, 27.5% commodities, 15% infrastructure, 15% resource equities, 10% short-duration fixed income and 5% gold. Real estate: Datastream Developed Real Estate Index through 12/31/89; FTSE EPRA Nareit Developed Index thereafter. The Datastream Developed Real Estate Index represents real estate companies from developed markets and is compiled by Refinitiv Datastream. The FTSE EPRA Nareit Developed Index is an unmanaged market- weighted total return index which consists of many companies from developed markets that derive more than half of their revenue from property-related activities. Commodities: Represented by the S&P GSCI Index through July 1998 and Bloomberg Commodity Total Return Index thereafter. The S&P GSCI Index is a composite of commodity sector returns representing an unleveraged, long-only investment in commodity futures that is broadly diversified across the spectrum of commodities, calculated on a fully collateralized basis with full reinvestment. Performance for the S&P GSCI Index prior to January 1991 is hypothetical back-tested, not actual performance, based on the index methodology in effect on the launch date and using actual historical constituent-level data to reconstruct the index’s returns. The Bloomberg Commodity Total Return Index, formerly known as the Dow Jones-UBS Commodity Index, is a broadly diversified index that tracks the commodity markets through commodity futures contracts. The index is made up of exchange-traded futures on physical commodities, which are weighted to account for economic significance and market liquidity. Infrastructure: 50/30/20 blend of Datastream World Gas, Water & Multi-Utilities, Datastream World Pipelines and Datastream World Railroads through 12/31/02; Dow Jones Brookfield Global Infrastructure Index thereafter. The Datastream World Index Series encompasses global indexes of companies in their respective sectors (World Gas, Water & Multi-Utilities; Materials; Oil & Gas; and Pipelines) and is compiled by Refinitiv Datastream. The Dow Jones Brookfield Global Infrastructure Index is a float-adjusted market-capitalization-weighted index that measures performance of globally domiciled companies that derive more than 70% of their cash flows from infrastructure lines of business. Resource equities: 50/50 Blend of Datastream World Oil & Gas and Datastream World Basic Materials through 12/31/02; S&P Global Natural Resources Index thereafter. The S&P Global Natural Resources Index includes 90 of the largest publicly traded companies in natural resources and commodities businesses that meet specific investability requirements, offering investors diversified, liquid and investable equity exposure across three primary commodity-related sectors: Agribusiness, Energy and Metals & Mining. Short-duration fixed income: ICE BofA U.S. Corporate & Government Index through 12/31/75; ICE BofA 1–3 Year U.S. Corporate Index thereafter. The ICE BofA U.S. Corporate & Government Index represents USD-denominated investment-grade debt publicly issued in the U.S. domestic market, including U.S. Treasury, U.S. agency, foreign government, supranational and corporate securities. The ICE BofA 1–3 Year U.S. Corporate Index tracks the performance of USD-denominated investment-grade corporate debt publicly issued in the U.S. domestic market with a remaining term to maturity of less than 3 years. Gold: Gold spot price in USD per Troy ounce. Global stocks: MSCI World Index, a market-capitalization-weighted index consisting of a wide selection of stocks traded in 24 developed markets. U.S. bonds: Bloomberg U.S. Aggregate Bond Index, a broad-based index that measures the investment-grade USD-denominated fixed-rate taxable bond market. Global Equities: MSCI World Index.
This document is provided to qualified institutional and professional investors or their advisors only for informational purposes and reflects prevailing conditions and our judgment as of this date, which are subject to change. It does not constitute investment advice or a recommendation or offer. We consider the information in this presentation to be accurate, but we do not represent that it is complete or should be relied upon as the sole source of appropriateness for investment. Past results are not necessarily indicative of future results. There is no guarantee that any historical trend illustrated above will be repeated in the future, and there is no way to predict precisely when such a trend will begin. The views and opinions are as of the date of publication and are subject to change without notice. Risks involved with investment, including potential loss of capital, should be carefully considered. Diversification does not ensure a profit or protect against loss.
The mention of specific commodities is not a recommendation or solicitation to buy, sell or hold any commodity interests. Strategies that trade in commodities involve a risk of loss. Investors should consider whether such services or products are suitable investments.
No representation or warranty is made as to the efficacy of any strategy or fund or the actual returns that may be achieved.
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