Why and how investing in commodities helps make a balanced portfolio

Portfolio diversification is a term that has been introduced previously for investors. The next step for any investor who has established his investment goal and risk appetite is to design a well-balanced portfolio with optimal asset allocation.  

Portfolio diversification across various asset classes guards your portfolio against any adverse effect on a single asset class. We have seen investors diversify their portfolios between equity, fixed income, real estate and commodities to provide desired balance and risk-adjusted returns over the long run.  

Tapan Patel, Fund Manager–Commodities, Tata Asset Management, said, “The current environment of global uncertainty, macro headwinds and geopolitical factors has given rise to the investment into commodities beyond gold and silver. Investors have realised the benefit of having portfolio allocation to commodities in recent years. War-like situations, trade wars, pandemics and changes in weather patterns have resulted in large price fluctuations in commodities. Investors may benefit from such price fluctuations with optimal asset allocation into commodities, which could protect the overall portfolio.” 

Investment into commodities may offer distinct benefits per various economic scenarios in growth and recessionary periods.  

Portfolio diversification is one of the key benefits which one may get through commodity investment. Investors may diversify their portfolios as per risk tolerance and financial goals. The outperformance in one asset class may offset the losses of other asset classes, providing balance to the portfolio. 

Hedging against inflationary time is the core factor where investors generally give higher weightage to commodities, especially Gold and Silver. “Commodities may provide portfolio protection against a surge in prices, being the “first respondents” to the higher demand and weaker dollar due to inverse correlation. Hence, allocation to other commodities beyond gold and silver could give better risk-adjusted returns over the long run,” said Patel. 

“Commodities prices generally tend to rise in economic expansion and growth, which may improve overall portfolio returns,” said Patel. In addition, geopolitical tensions and supply disruptions may result in substantial price increases in commodities like crude oil, industrial metals, and agricultural commodities. Such moves could positively impact portfolio returns. 

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Investors have options to invest in commodities through registered commodity exchanges, ETFs, Sovereign Gold Bonds (SGB) and various schemes of Mutual Funds having commodity exposure. The various asset management companies (AMCs) now offer an opportunity to invest in commodities through hybrid/multi-asset schemes. Many schemes follow a fund-of-fund structure and primarily invest in Gold ETFs. At the same time, few offer investment through exchange-traded commodity derivatives (ETCD), adopting a beyond-gold approach with diversification in other commodities and gold. 

“Over time, portfolios are more likely to become unbalanced when markets are unpredictable. One should rebalance them timely so that the investments continue supporting long-term financial goals without running unintended risks,” said Patel.