Are Commodities a Necessary Portfolio Component?

Standard Chartered said there was no bottom in sight until "money managers in the market conceded that matters had gone too far".

"Given that no fundamental relationship is currently driving the oil market towards any equilibrium, prices are being moved almost entirely by financial flows caused by fluctuations in other asset prices, including the dollar and equity markets," said Standard Chartered.

Josh here – This is the problem with the clarion calls of the last decade to make commodities a part of one’s asset allocation because they are “uncorrelated” to traditional stock / bond portfolios. The more people adopt this suggestion, the more “financialized” commodities become, and the less helpful for diversification. And everyone adopted this suggestion, judging by asset flows during that decade and into 2011.

We don’t include any slots for commodities in our asset allocation models and we never have. It’s not that they can’t go up, or that we predicted the current rout – it’s that long-term portfolios work just fine without them and their benefits as a diversifier have been overstated by the fund factory industry.

Moreover, looking for pure exposure to continuing-contract spot price in an exchange-traded vehicle is a jungle. You end up with high costs, a bizarre contango problem when contracts roll, or, in a worst case scenario, a product that doesn’t actually work in tracking the commodity at all (I can think of plenty of them off the top of my head).

While many advisors keep a sleeve in their portfolios for “hard assets” of between 3 and 10%, we simply opt out. You don’t get paid equally for every risk you take, and some risks overlap. Emerging market equities and commodities being just one obvious example. Our clients don’t need the same risk spread across two different asset classes, especially if it comes in a poorly conceived package.

Besides, who the hell even knows what drives these things? You’d have thought record money-printing, booming populations and unprecedented turmoil in the MidEast would have been a positive. Nope. Even Jeremy Grantham, one of the smartest investors in the world, doesn’t have the answer to this question.

Lastly on this topic – there are many segments of the US stock market that rise in tandem with up-cycles for commodity prices. Further, there are entire geographic regions where mining and drilling companies make up a huge portion of stock market capitalization. The countries range from the developed (UK is lousy with metals companies) to the emerging (Latin America is one big resources bet, as is Australia). So by virtue of benchmarking to MSCI All Country World Index, you’re already in-line for commodity exposure, in good times and bad.

If we can help you figure out what’s going on with your investment portfolio, hit us up here:

Ritholtz Wealth Management

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