How to Allocate Commodities in Portfolios

Conventional wisdom often dictates that the ideal percentage is 5% to 10%. However, at times when bonds and equities are slumping and inflation is high — the exact scenario investors are contending with today — it’s appropriate to challenge conventional wisdom.

Performance suggests that this is the correct course of action. For example, the Invesco DB Commodity Index Tracking Fund (DBC A) is up more than 30% year-to-date while the S&P 500 and nearly every bond exchange traded fund on the market are in the red.

“Rising inflation generated a compelling backdrop for various commodities during 2021. The price of WTI crude oil began 2021 at roughly $48 per barrel and climbed to $75 per barrel by year-end,” note Morningstar analysts Amy Arnott and Emory Zink.

Of course, high oil prices help the commodities complex because crude is one of the most consumed and heavily traded commodities, but it’s not the only driver of DBC upside. The Invesco fund, which follows the DBIQ Optimum Yield Diversified Commodity Index Excess Return, features exposure to the futures contracts of 14 heavily traded commodities. That diversity makes the fund appropriate for a broad swath of investors.

“Historically, commodities have generally been a strong hedge against inflation, but it is not clear whether this will hold true in the future. Over the past two years, major commodity indexes have actually had a slight negative correlation with inflation,” add the Morningstar analysts.

Another advantage of DBC’s diversified approach, which potentially speaks to allocating a higher percentage of a portfolio to the fund when inflation is high, is that diversity ensures some reduction in correlations. For example, oil and copper correlations to stocks ticked higher last year, but gold and other commodities represented in DBC did not.

“During inflation spikes, commodities often provide diversification value and deserve consideration in a portfolio with a variety of potential market environments top of mind. Notably, gold continues to fill a valuable role as a buffer against equity market volatility,” conclude the Morningstar analysts.

With about 15% of its weight allocated to agriculture commodities, DBC also offers an effective avenue for profiting from food price inflation while avoiding the volatility that often comes along with investing in individual soft commodities futures contracts.

For more news, information, and strategy, visit the ETF Education Channel.