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Commodities and property – why they make sense in multi-asset portfolios
We look at the key benefits of these often-misunderstood assets and how we mitigate their risks in our multi-asset portfolios.
Most of us have some understanding of what commodities and property are. Gold, silver, wheat, oil, sugar and coffee are all commonly known and used commodities. Most of us also have experience of the property market through our homes, offices and the retail spaces where we shop and eat. All these assets are tangible and have an intrinsic value in the world. So far, so familiar.
But when it comes to investing in commodities and property, the idea can be met with suspicion. Investors may worry about liquidity, the level of specialist knowledge needed to invest and the high transaction costs associated with these assets. In addition, they may not fully understand the role that commodities and property can play in an investment portfolio.
Deeper diversification
Diversification is one of the biggest benefits of adding commodities and property to an investment portfolio. As the following chart shows, both have low correlations with each other and with traditional investments like equities and bonds. This means that they tend to perform independently of each other in different market conditions and at various points during the economic cycle.
Source: FE fundinfo, 10-year period in pounds sterling, as at 27 June 2023.
And with property, investors can deepen the diversification within their portfolios further by investing across sectors, from retail and offices to industrial assets. This multi-sector approach provides exposure to different property cycles.
The global commodities market is even more diverse, and each individual raw material, be that oil, copper, grain or beef, has different drivers of demand and supply. While prone to volatility, commodities can produce stellar returns when their prices spike – as was seen in 2016, 2021 and 2022, where they were the best-performing asset class. 2022, in particular, was a standout year, with returns far outstripping those of equities and bonds, both of which generally had a torrid 12 months as can be seen in the chart below.
So having a good spread of investments across a mix of equities, bonds, property and commodities can enrich diversification within a portfolio, bolster its resilience to sudden shocks and reduce the risk of all the holdings underperforming simultaneously.
Inflation-resilient portfolios
We’ve grown used to higher interest rates and inflation being features of the current financial landscape and their erosive effects on the value of investments. In this environment, a simple portfolio of just equities and bonds isn’t always enough to help protect investors' wealth. However, adding real assets like property and commodities, which have embedded pricing power, can bolster portfolios and help mitigate some inflationary pressures.
Commercial property, like office blocks and hotels, tends to be subject to very long leases, with rental increases often linked to inflation. Therefore, as inflation rises, so should rental income. This generates capital that investment managers can reinvest in that property to increase its value or to buy other assets for the portfolio.
Commodities can also act as a hedge against inflation because their prices tend to increase in line with the overall level of prices in the economy. For example, higher food prices are usually preceded by higher costs for raw ingredients such as wheat, sugar cane or corn, which are all affected by different supply/demand dynamics.
Similarly, we feel the impact of rising oil prices almost immediately when we pay more to fill our cars with petrol. While more expensive goods negatively impact our wallets, you may be rewarded in your investment portfolio if you have exposure to any of the underlying commodities. Equally, gold and other precious metals tend to perform well in inflationary conditions, as investors’ desire to find perceived safe-haven assets can drive up their demand.
Property prowess
As well as being an excellent diversifier and inflation hedger, property can bring other benefits to an investment portfolio.
- Steady income stream – property investments can provide consistent and predictable cashflows through rents.
- Capital appreciation – property investors may benefit from capital appreciation in the underlying buildings or assets. Property values tend to appreciate over the long term, especially if there’s strong demand for particular assets. In addition, skilful active management, such as redevelopment or refurbishment, can also increase an asset’s value.
- Sustainability goals – investing with managers who take a responsible approach to property and who manage assets in a way that delivers social value and positive environmental outcomes can help investors achieve their own sustainability goals.
- Lower volatility – property can offer equity-like returns but with lower volatility. Given the long-term nature of property investments and the slow movement of the market relative to equities, they tend to be more stable. Property assets are typically valued monthly, quarterly or annually, which can help smooth returns, although remember that the value of all investments can go down as well as up, sometimes significantly.
- Intrinsic value – as property is a physical asset, it has worth beyond its investment value. So, for example, even if an investment strategy fails or a development project collapses, there will always be residual value in the building itself, the fixtures and fittings, and the underlying land.
Accessing the benefits with less risk
Holding a wide range of asset classes can help manage risk in portfolios, improve their resilience to sudden market shocks and deliver better outcomes for investors. This is why we include a broad mix of assets, including commodities and property, in our multi-asset portfolios.
With commodities, we track their performance through indices rather than owning the physical goods or raw materials. This means the portfolios can benefit from rising commodity prices without incurring storage or transportation costs.
Meanwhile, Royal London Asset Management’s experienced property team directly buys and actively manages the high-quality bricks-and-mortar assets in the property fund used in our multi-asset portfolios. And environmental, social and governance (ESG) integration plays an important role when the team is determining which properties to buy and sell, and how to minimise their impact on the environment and local communities.
The other important point to note is that this property fund is only available to our pension customers – there are no institutional investors. That means it has large and regular cashflows, with minimal risk of sudden withdrawals, so liquidity is well managed.
To find out more about our approach to multi-asset investing, read our guide or speak to your usual Royal London contact.
