With stocks at all-time highs, it’s easy to brush off the March sell-off accrued at the hands of the war in Iran as a simple case of geopolitical events rattling global markets.
That it was, but investors shouldn’t be dismissive within this bit of albeit recent history is a learning opportunity. It wasn’t just stocks that faltered immediately following the start of the conflict. Bonds did the same. Even gold followed suit, but that doesn’t diminish the point that in broad terms, commodities held up and remain key portfolio diversification tools.
(Image Courtesy: Morgan Stanley)
The point is many investors, and advisors for that matter, rely heavily on stocks and bonds, betting the latter will pick up the slack and provide protection during times of geopolitical stress. Commodities often go overlooked, but that shouldn’t be the case. In fact, commodities have unique traits that can make the asset class invaluable in client portfolios.
Make the Commodities Call
Helping clients understand the differences between commodities, bonds and stocks can go a long way toward assuaging the uninitiated.
“Stocks are claims on future earnings, while bonds are claims on nominal cash flows. Both tend to be more vulnerable when inflation is higher and growth is lower,” observes Morgan Stanley. “Commodities, by contrast, tend to reprice upward when scarcity becomes a dominant concern, and that may work in to investors’ advantage.”
That explains why when bonds betrayed investors following the start of the Iran war, broad baskets of commodities. Said another way, commodities carry positive geopolitical risk premiums, which can prove advantageous relative to equities and, in this case, bonds.
Indeed, it’s no fun when stocks and bonds fall in unison and that’s obviously bad for 60/40 portfolios, but as Morgan Stanley notes, even modest allocations to commodities can ameliorate that scenario.
“From Feb. 28, when the conflict in Iran started, to March 31, a typical portfolio with 60% of stocks and 40% of bonds would have posted a loss of 3.6%. Including only a modest 5% allocation to commodities, the portfolio’s performance would have improved to a gain of nearly 1%,” adds the bank. “During that same period, a diversified basket of commodities including oil, metals and agriculture products advanced 13.5%.”
Commodities Are Complements, Not Replacements
Maybe they’ve watched “Trading Places” too many times, but some clients may be nervous about commodities. A couple of points can help them get past those nerves. First, the inclusion of commodities in a portfolio isn’t to replace equities and fixed income, but rather to complement those assets.
Second, commodities are true diversifiers. They consistently sport low correlations to stocks and bonds, implying protective properties when stocks and bonds fall in tandem.
“The bottom line for investors focused on long-term portfolio resilience is not to replace stocks or bonds, but to complement them,” concludes Morgan Stanley. “A modest allocation to a diversified set of commodities may provide exposure to a unique opportunity—one that traditional asset classes alone may not fully capture.”
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