Over the last few weeks we have covered the major asset classes that investors include in their portfolio, namely cash, bonds, shares and property. “Alternatives” is an all- encompassing term that includes anything else.
This week we look at one of the most well known Alternatives, commodities.
Some people like to include exposure to commodities within their portfolio, the most popular with non-professional investors tend to be gold and oil.
What: Commodities are tradeable goods. Commodities include metals (e.g. silver, gold), energy (e.g. oil), livestock (e.g. pork bellies) and agriculture (e.g. coffee, corn).
Why: People invest in commodities due to a view they have on the market. For example, if you believe that pork bellies are undervalued, then you need to get out more and stop researching the price of pork bellies! Or you could try investing in them to benefit when the price rises.
Other commodities, notably gold, are used to express a view about risk. Generally when global risks increase, the value of gold increases because it is an absolute store of value. That is, it has value in and of itself, and in times of crisis the price of gold rises. During the period from 2007 until the end of 2010, the price of gold increased at an average annual rate of c.23%.
How: Generally speaking, it is quite difficult to invest in commodities directly, because they trade in very large parcels that make it hard for retail investors to participate. The easiest commodity to invest in directly is gold. For example, if you want to go old school you can head to the Perth Mint and buy yourself some gold coins. Other commodities, like oil, are a little harder to buy and store directly.
The easiest ways to invest in commodities are:
Share Purchases: Although you cannot purchase all commodities directly, you can directly purchase shares in a company that trades in that commodity. For example, to get exposure to gold you could invest in a gold mining company.
Passive Funds: There are exchange-traded funds available that will give you exposure to commodities, e.g. a Gold ETF or an Oil ETF. The price of these ETFs will rise when the price of the underlying commodity rises, and vice versa.
Managed Fund: There is also the possibility of investing in a managed fund, where the manager specialises in a particular commodity.
Risks: Investing in commodities is purely a price play, you will only benefit if the price of the commodity increases. Unlike shares, bonds or property, there is no income component of commodity investing (i.e. you do not receive a dividend, interest payment, or rent).
Commodity investing can be complex and the prices are very volatile. The people that trade and invest in commodities are highly specialised, for example the people that invest in gold do it day in and day out, for their whole career. It is not an asset class that is recommended for novice investors.
If you want to invest in commodities, then ideally it should form only a small part of your portfolio (e.g. 5%) due to the risks, complexity and specialised knowledge required.
Next week we are going to look at another common Alternative, Private Equity.
The information in this blog is of a general nature only and may contain advice that is not based on your personal objectives, financial situation or needs. Accordingly you should consider how appropriate the advice (if any) is to those objectives, financial situation and needs before acting on the advice.