Why you should have commodities in your portfolio

Jayant Manglik

Commodities have been a major revelation this millenium and several investors have added it to their portfolios for a variety of  reasons. One key factor has, of course, been the outstanding returns commodity investments have given since the year 2000. Secondly, globalization has opened the doors to true diversification in India.

Usually financial advisors recommend an allocation between 5% and 20% in commodities. This is because if you look at returns over the last forty years or so, data shows that commodities offer diversification and good returns with similar volatility as equities. This information usually takes one by surprise as commodities are perceived to be more volatile and therefore more risky. In the western world as well as in India, commodities have given smart real returns to investors & much above the inflation rate. The dot-com bust in 2001 also saw the emergence of commodities as the newest asset class to invest in with gold leading the rally. Later in 2004, the launch of the SPDR Gold Trust ETF completely revolutionized investments into gold from retail investors.

Before getting into commodities you need a sound investment strategy. This should be based on your age and risk profile and financial status. In case of doubt, one should limit the investment into commodities to single-digit percentages. Investment in commodities should be used to diversify risk and reduce volatility of the portfolio, not just for higher returns. In terms of priorities, please ensure that your investments in stocks and bonds are in place before attempting to invest in commodities. Within the commodity investment universe, investing in gold is the easiest decision in terms of understanding, comfort and products available. Commodities will help you make a diversified and balanced portfolio with better risk-adjusted returns as well as act as a hedge against inflation.

One common grouse is that commodities don't pay dividends. Well, they also don't go bankrupt! The value of a commodity can fall but will never go to near zero as in the case of some equity shares. All commodities have an intrinsic price. So if you invest in gold at the current price, you can look forward to a change in price which may even be steep but it will never be unsaleable or worthless. And taking delivery is better than trading futures. One can buy gold ETFs through the stock markets or take physical gold delivery too through the commodities futures markets.

Another way is to invest in commodity stocks like Hindalco where the price of the commodity will be a major factor in the price movement. This brings in other factors too like the perception of the industry and management into the price of the share but it is usually a fair representation of the value of the commodity as that will usually be a dominant factor if there are no other major subjectives.

It was the case earlier that only large investors (smart money!) would invest in commodities. Now, with the introduction of smaller lot sizes and electronic exchanges, it is possible even for retail investors to participate by buying futures which culminate into delivery. Of course, the system is different from equities and one has to learn them. For example, your commodity delivery maybe in demat form but the underlying is in a warehouse and if you happen to invest in an agri-commodity, then there is a 'valid delivery' date by which you must sell or get it revalidated as agri-commodities have a shelf life. Once the process is understood, making buy/sell decisions in commodities can be easy because it is rational, based on demand & supply and seasonality is inbuilt in agri commodities.

Typically gold is the first point of entry into commodity investment. This can be followed by agri commodities which are seasonal. The experts can go ahead and invest in other commodities, preferably dealing in delivery rather than in futures. In any case, diversifying your portfolio by investing in commodities is a must in these times.

The author is President - Retail Distribution, Religare Securities Limited

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