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Commodities – an integral part of strategic allocation

Max Holzer

Article by Daniel Bathe

Portfolio manager in Union Investment’s Multi Asset segment

Commodities can contribute significantly to the diversification of a portfolio. And in times of rising price levels, commodities also offer a certain degree of protection against inflation. Union Investment’s Commodities-Invest fund provides institutional investors with broad access to the commodity market.

Institutional investors already began to turn their attention to oil, copper, gold, etc. well before inflation and commodity prices started to pick up. After a temporary slump in the spring of 2020 due to the outbreak of the coronavirus pandemic, sentiment swiftly returned to a more upbeat note. Driven by hopes of a robust economic upturn after the pandemic, prices of cyclical commodities – especially oil and metals – advanced strongly. “In the commodity markets, economic optimism resurfaced quickly,” says Daniel Bathe, commodities expert and senior portfolio manager at Union Investment. In recent months, the positive mood has translated into substantial price gains.

Late-cycle environment and transition to green energy are providing a tailwind

Union Investment’s commodity experts believe that the upturn has not reached its peak yet despite the now elevated price levels. Commodities are deemed a late-cycle asset class that typically comes into its own towards the end of the economic cycle when the boom phase is waning. There are many indications that the economic cycle in major economies has matured. Economic growth should continue, albeit at a slightly slower pace. This is when commodities come into their own.

Certain structural factors also favour commodities. “The transition to green energy could trigger a new super cycle in the coming years,” explains Bathe. As the economy transforms to become more sustainable, new winners are emerging. Industrial metals are a key beneficiary of advancing electrification and decarbonisation. For example, nickel is becoming increasingly important in connection with the production of batteries, and copper has a wide range of applications relating to electricity. “Up to 30 tonnes of copper may be required to build and install a single wind turbine,” Bathe points out.

A new 'super cycle' anticipated, triggered by the transition to green energy

Commodity spot price index

A new 'super cycle' anticipated, triggered by the transition to green energy
Sources: Bloomberg, Union Investment, as at 19 July 2021.

Commodities are a key element for portfolio diversification

Against this backdrop, the number of investors who include commodity investments in their portfolio has been growing. And commodities have a part to play in a risk-conscious investment strategy. “Investments in commodities are an essential element of strategic asset allocation, because they contribute significantly to the diversification of a portfolio,” explains Bathe. It is true that commodities are typically a more volatile asset class, but thanks to a low level of correlation with many traditional asset classes, they can generate a positive contribution to the diversification of risk in the overall portfolio over the long term.

Proprietary commodity index has decisive competitive advantages

Union Investment’s Commodities-Invest product offers access to the commodity market based on an opportunity-oriented approach. The fund was launched in 2006 and replicates Union Investment’s proprietary RADAR index, in which the three commodity subsectors of energy commodities, precious metals and industrial metals are each weighted at one third. Unlike providers of other benchmark concepts, Union Investment thus deliberately weights all subsectors equally in order to avoid the dominance of highly volatile energy commodities that is a typical feature of most other concepts. In addition, spot prices are made investable through roll optimisation along the forward curve. “The weighting of subsectors at one third each, the roll optimisation and our active allocation in the commodity subsectors are clear USPs of our proprietary strategy compared with those of our competitors,” emphasises Bathe, who is responsible for managing the Commodities-Invest fund.

The RADAR index concept developed by Union Investment has clearly outperformed standard commodity indices in the past

Comparison of the RADAR index and standard commodity indices

Das von Union Investment entwickelte Index-Konzept RADAR hat die die Standard-Rohstoffindizes in der Vergangenheit weit übertroffen
January 2014 to June 2021; sources: Bloomberg, Union Investment, as at 19 July 2021. Note: The chart illustrates the performance of different commodity indices. The Commodities-Invest fund replicates the intelligent RADAR benchmark concept that was developed with Union Investment. The index weights individual commodities and rebases these quarterly. It also carries out dynamic roll optimisation.

Steady inflows are proof of strong interest among investors

The Commodities-Invest fund has recorded significant inflows since well before the pandemic crisis of 2020, a year in which the fund closed with a gain of almost 3 per cent. “With currently more than €1 billion in assets under management, our fund is one of the largest and most successful in its category in Europe,” says Bathe. In spite of its size, the fund remains a highly liquid investment because additions to the fund assets are made via derivatives trades rather than purchases of physical commodities that need to be warehoused. “Investments in commodities offer diversification benefits in the long term. All investors should therefore consider including this asset class in their strategic asset allocation,” concludes Bathe.

Info

The Commodities-Invest fund is a widely diversified portfolio comprising key commodities. The fund managers aim to invest equally in the energy, industrial and precious metal sectors. Investments in agricultural commodities are deliberately avoided. The first stage of portfolio construction is to replicate the intelligent benchmark concept that was developed with Union Investment. The index weights individual commodities and rebases these quarterly. It also carries out dynamic roll optimisation. In the second stage, the portfolio managers actively implement investment decisions made on the basis of inhouse research. The fund was launched on 25 April 2006 and comprises assets worth €1,021.66 million.

Investors should take the following risk factors into account in their decision about a potential investment in this fund:

  • Market-driven price volatility and income fluctuations as well as credit risk of individual issuers/counterparties.

  • Concentration of risk in specific sectors may lead to increased price volatility.

  • Investments in emerging markets and developing countries may entail heightened price volatility and downside/default risk.

  • The use of certain investment instruments (e.g. derivatives) may entail heightened price volatility.

  • Heightened price volatility as a result of the composition of the CommoditiesInvest fund.

  • Potential exchangerate risk.

 


As at 6 July 2021.