The last two years have seen a strong bull market, followed by record-high inflation and the first interest rate hikes in years. While it’s hard to find an asset class that has gracefully rode out the shifting environment, leaders in the ETF industry are aligned when it comes to the one alternative asset class investors really can not live without in a portfolio.
In a conversation at with Dave Nadig, financial futurist at ETF Trends and ETF Database, at Exchange: An ETF Experience, Ross Frankenfield, managing director at Harbor Capital Advisors, and Sébastien Page, head of global multi-asset at T. Rowe Price, each emphasized the need for commodities allocation in a portfolio.
“Commodities make a lot of sense. It’s kind of that left-for-dead asset class that typically goes through these long boom and bust cycles, but I think they have inherently great diversification, as well as portfolio risk dampening properties,” Frankenfield said.
Frankenfield pointed to the inherent diversification, or low correlation property, associated with commodities and the asset class serving as a useful inflation hedge.
“Commodities themselves are spot assets, they reflect supply and demand imbalances that are occurring today,” Frankenfield added. “Whereas stocks and bonds are forward-looking assets, discounting future Fed policy, interest rate moves, or discounting future cash flows and earnings.”
Unscrambling The Allocation Puzzle
Investors are often puzzled about where they should reduce their allocation to add commodities exposure.
“One argument for adding commodities and taking from fixed income is if you’re one of those advisors that has gone very short duration within your fixed-income portfolio,” Frankenfield said.
“You’ve inherently removed that ballast component in terms of not having as much exposure and sort of duration control of long bonds,” Frankenfield added. “In that environment, having the ballast that commodities have historically provided in terms of that negative correlation, it can make some sense to take from that portion of the overall asset allocation.”
While commodities aren’t attractive when they’re not bustling, as they often aren’t, investors won’t know they need them until it’s too late, thus making them an important aspect of a diversified portfolio.
“It’s so easy to sit here right now and say ‘oh, you need commodities in your portfolio’ because they’ve just rallied hard. When you go back three years, four years, sitting in our asset allocation committee debating – because inflation was nowhere to be seen – we had a hard time hitting 2% [portfolio allocation],” Page said.
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