Should Canadians Add Commodities to their Portfolios?
In The Little Book of Commodity Investing (review to follow later in the week), Toronto-based portfolio manager, John Stephensen argues that commodities are a separate asset class and deserve a place in every portfolio. He cites two papers to support his viewpoint. The first titled Facts and Fantasies about Commodity Futures concluded that “fully-collateralized commodity futures have historically offered the same return and Sharpe ratio as equities” but the returns were “negatively correlated with equity returns and bond returns”. The other study by Ibbotson Associates titled Strategic Asset Allocation and Commodities also found that an equally weighted, monthly rebalanced composite of four commodity indices show “low correlations to traditional stocks and bonds, produce high returns, hedge against inflation and provide diversification through superior returns when they are needed most”. Mr. Stephensen goes on to say that his preferred route for investing in this asset class is through stocks of commodity-producing companies.
Whether or not you buy Mr. Stephensen’s argument, I wonder if Canadian investors should obtain even more exposure to commodities in addition to what they already own in the energy and materials stocks either directly or in their mutual funds. With energy and materials accounting for just 14.1 percent of the S&P 500 index, US-based investors may want to explore whether they should add commodities separately. But the weight of these two sectors in the S&P/TSX Composite index is more than three times as much at 47 percent and Canadian investors may already have too much riding on commodities. Even in a portfolio like the Sleepy Portfolio with just 20 percent allotted to Canadian stocks and 22.5 percent each to US and EAFE securities and a further 5 percent to emerging markets, the total exposure to the resource sector in the equity portion comes to 25.8 percent (18 percent of the total portfolio).
Canadian investors have a further problem. As hewers of wood and drawers of water, our economic fortunes (and therefore our wages, our home prices and other sectors of our economy) are already closely tied to that of commodities. It seems to me that putting even more eggs in the commodity basket may not be prudent way of managing risk.