The case for commodity focused investment trusts
David Prosser explains why the sector could be a good way to diversify your portfolio.
Most investors recognise the principle of portfolio diversification – the importance of not putting all your eggs in one basket – but in practice they don’t always execute effectively. Quite often, diversification simply means holding some bonds and cash alongside equities.
Even in the investment trust world, where there is no shortage of opportunities for broader diversification, much of the attention in recent times has been on infrastructure and private equity, with other asset classes routinely overlooked.
In that context, now might be a good time to investigate one of these overlooked areas in particular – and to run the slide rule over the various investment trusts that offer a route into it. No fewer than seven investment trusts offer exposure to commodities, an interesting and broadly diversified sector that can offer investors numerous benefits. .
Hard commodities include resources such as oil, gas and coal, as well as precious and industrial metals. Soft commodities are agricultural products – everything from livestock to coffee and cotton. That diversity naturally means that commodity prices don’t all move in the same way at the same time – though the asset class is often seen as a bellwether for the global economy.
Why consider investing in commodities now? Well, one argument relates to the strength of demand, particularly for commodities needed to decarbonise energy production. Demand for metals and minerals such as lithium, nickel and cobalt – all crucial in battery production – has seen prices rise sharply.
Energy resources, including oil and gas, but also uranium and the materials necessary for solar and wind power production, are also in demand as energy-intensive data centres proliferate.
Demand for metals and minerals such as lithium, nickel and cobalt – all crucial in battery production – has seen prices rise sharply.
David Prosser
Equally, supply side factors support commodity prices too. Dialling up production of sought-after commodities is not straightforward – it takes time and money to open new mines, for example. On the soft commodities side, crop harvests are planned months and years in advance and are susceptible to factors such as adverse weather. Across the whole asset class, it’s difficult to quickly increase supply to respond to increasing demand, and that can push up prices.
A third argument for commodities is that they offer a more powerful source of diversification than other asset classes traditionally seen as an alternative to equities. Indeed, commodities have a very low correlation to equities, tending to outperform at times when the stock market has struggled. Certain commodities – notably gold and silver – are also regarded as a good hedge against inflation.
Another point to consider is the strong long-term track record of performance from commodities. As with equities, investors often need to contend with short-term volatility, but their patience has, in the past at least, been rewarded. Bloomberg data suggests gold and copper have delivered returns of 660% and 435% respectively since 1990, well ahead of the 255% generated by the FTSE 100 Index of shares in leading UK companies.
One word of warning. Most of the seven commodity-focused investment trusts predominantly invest in the shares of companies involved in commodities production rather than the commodities themselves. And these shares don’t always move in line with commodity prices; that’s something to take into account.
Nevertheless, the investment trust sector offers a much easier route into commodities than trying to invest directly, which isn’t typically straightforward unless you have very significant wealth. And the closed-ended structure of funds – plus their unique ability to take on gearing – makes investment trusts an ideal way to explore this asset class. Commodities certainly won’t be for everyone, but if you’re looking for diversification opportunities, they’re worth considering.
David Prosser
David is former Business Editor of The Independent, Personal Finance Editor of the Daily Express, and Deputy Editor of Money Observer magazine. He writes regularly for the AIC.
