Have You Got The Metal For Commodities?

“Get out of the dollar, teach your children Chinese and buy as many commodities as you can”.  So says Jim Rogers, a former peanut seller, now billionaire and co-founder of the Quantum Fund* along with George Soros.

Rogers believes in macro-economic trends and is a big supporter of commodities as an asset class.  He disagrees with those who think that commodities are fundamentally riskier than equities, highlighting that commodity indices are less volatile than the NASDAQ (our research corroborated this by showing the Goldman Sachs Commodity Index to be marginally less volatile than the NASDAQ using standard deviation as a measure – source, Lipper/Hindsight, 1 June 2007 over 5 years).

But how does one gain exposure to commodities, short of storing a ton of pork bellies in our garage?

Well for the majority of us the most practical way is through a fund that invests in the shares of commodity companies or through an Exchange Traded Fund (ETF - a form of index tracker) linked to one of the commodity future exchanges.  It is also possible to invest in what‘s known as a structured product, that offers returns linked to a basket of commodities over a set period of time (often with some form of capital guarantee) – some of you may recall us bringing to your attention the Dawnay Day Quantum series of Protected Commodity Plans here in Minerva.

It is not possible for a private individual to go into the commodities futures exchange and begin trading – not least because large sums of money are needed, along with nerves of steel.  There are several drawbacks, however, with the main ways of gaining commodity exposure.

Firstly, if you are buying into a commodities fund that invests into the shares of companies exposed to the commodities sector (for example, mining companies), you are essentially exposing yourself to equity risk, as many of the causes of the movement in the share price will not be directly linked to the value of commodities – it may be that the share price drops because the market as a whole is dropping, but the price of copper might still be going up.

Secondly, the structured product route is great if you are happy to lock your money into an investment for a number of years, but a bit limiting if you require ready access to your money or have a shorter investment horizon.

Finally, ETF‘s, although very liquid and probably the most direct way of gaining commodity exposure only expose you to one commodity per fund, so you could be left with the difficulty of constructing your own portfolio.

And this is where one has to be careful.  Commodities are unlikely to be the investment panacea for a portfolio, without careful consideration as to the correct asset allocation and stock distribution; this is a decision that most of us simply aren‘t comfortable or able to make on our own.  It may be better, therefore, to select an investment that incorporates commodity exposure but along with other asset types – ensuring the correct level of diversification and risk management.

For example the SVM Global Opportunities Fund and the Cazenove Multi-Manger Diversity Fund both provide exposure to commodities.  Also, two of our own funds currently have exposure to commodities (the Chartwell Cautious Growth Fund and the Chartwell Balanced Income Fund), whilst the Chartwell Strategic Growth Fund has the ability to invest in commodity linked assets.

Commodities certainly have a part to play as part of a balanced portfolio, and are often used as a long term hedge against inflation; however, investors should consider carefully how much of their portfolio they wish to allocate to this asset class and how they‘re going to gain exposure – otherwise, it‘s clear out the garage time and make room for those pork bellies!

[Source: Lipper/Hindsight, Goldman Sachs, BBC Online, www.jimrogers.com, SVM Asset Management, Cazenove Capital]

*The Quantum Fund was the first of a series of hedge funds established by Soros and Rogers in 1970.