Considering commodities in multi-asset portfolios

Commodities can seem like a specialist area of the market, but they tend to come into sharper focus when inflation, geopolitics or supply disruptions start to affect day to day prices – and, by extension, portfolio outcomes.

This article explores commodities and the role they can play in diversifying multi asset portfolios, using the Iran war as a current example of how different parts of the asset class can behave in practice.

While they are not typically a core holding for most investors, commodities can play a supporting role in some multi asset strategies. As with any allocation decision, it is important to weigh the potential benefits against the risks – and to consider suitability for each client’s objectives, time horizon and tolerance for volatility.

Commodities are essentially raw materials that can be traded globally. They are commonly classified into:

• Energy (oil, gas, refined products)
• Metals (including precious metals like gold and platinum, and industrial metals like copper and aluminium)
• Agriculture
• Livestock

Each sector has distinct economic drivers and portfolio characteristics. Their prices are driven largely by supply and demand dynamics, which can be influenced by economic activity, geopolitics, weather patterns and even technological change.

Investors don’t tend to hold commodities directly. Instead, exposure is often gained through funds or indices that track commodity prices using futures contracts or similar instruments.

The global commodities market is highly diverse, with each commodity sector having different drivers of demand and supply.

Commodities are sometimes considered for their diversification properties. Their returns don’t always move in line with traditional asset classes such as equities and bonds. As a result, they may behave differently at various points in the economic cycle, which can help spread risk across a portfolio. The global commodities market is highly diverse, with each commodity sector having different drivers of demand and supply.

Another characteristic often associated with commodities is their sensitivity to inflation. Because they represent the building blocks of economic activity, commodity prices can rise when input costs increase. In certain environments, this has meant they perform better during periods when inflation is rising and the real value of financial assets is under pressure.

• Energy commodities (oil, gas and refined products) are highly sensitive to geopolitical risk, supply shocks and global economic growth.
• Metals are split between precious metals (e.g. gold, silver, platinum), which tend to hedge inflation, and industrial metals (e.g. copper, aluminium) which are pro-cyclical and linked to industrial activity.
• Agricultural (soft) commodities reflect weather patterns, crop cycles, and biofuel demand, while livestock prices depend on feed costs, disease risk and production cycles.

Commodities carry a number of risks that advisers need to consider carefully for client suitability. One of the most significant is volatility. Prices can move sharply over short periods, driven by unpredictable events such as geopolitical tensions, supply disruptions or changes in weather. This can lead to pronounced swings in returns that may not be suitable for all investors.

Commodity returns can also be complex with the choice of commodity benchmark a critical factor because it determines sector exposure and therefore the sensitivity to different macroeconomic risks. Broad indices vary significantly in construction leading to different levels of exposure to the Energy sector which can materially affect the inflation‑hedging characteristics, cyclicality, correlation with equities and bonds, and overall risk–return outcomes.

Many investment vehicles rely on futures markets rather than spot prices, meaning returns are influenced by factors such as contract roll costs and the shape of the futures curve. These technical elements can detract from returns and may be difficult for clients to understand or anticipate.

Commodities do not generate income unlike equities (dividends) or bonds (coupons), so returns rely entirely on price movements. This can make them less attractive for income focused portfolios and can also result in extended periods of weak performance if prices stagnate or fall.

Finally, commodities can underperform for long periods. While they may perform well in certain market environments, there is no guarantee that favourable conditions will persist, and timing allocations can be challenging.

As noted earlier in this article, the global commodities market is highly diverse, with each sector having different drivers of demand and supply.

Oil prices have soared since the war began in late February, driven by the blockade of the Strait of Hormuz and strikes that have damaged energy infrastructure in the Gulf region. Global oil supply fell sharply in April, prompting traders to warn that prices could rise further as the summer travel season approaches.

Meanwhile, gold prices have fallen sharply since the conflict began – in contradiction to the usual view of gold as a safe-haven asset in times of market turmoil, uncertainty or geopolitical tension. The rationale for this is that the Iran conflict has stoked fears of persistent inflation due to higher oil prices which weakens gold’s role as a store of value. Industrial metals – which are key materials for many products – are expected to perform better due to ongoing supply challenges.

Turning to agricultural commodities, disruption to supplies of fertiliser and its key ingredients has pushed up prices, exacerbated by higher energy costs which feed directly into both fertiliser production and agricultural operations. Reduced fertiliser use in response to rising costs could lower crop yields, raising the risk of higher food price inflation and increased food insecurity globally, especially if supply disruptions continue to persist.

Client objectives, risk tolerance and time horizon should all play a central role in determining whether commodities have any place in a portfolio.

Where commodities are used in a multi-asset portfolio, allocations are typically modest and considered in the context of the overall portfolio. Their inclusion should be driven by a clear purpose, such as diversification or exposure to specific economic conditions, rather than short term market views alone.

Suitability remains key. Client objectives, risk tolerance and time horizon should all play a central role in determining whether commodities have any place in a portfolio. Clear communication is also important, particularly given the potential for volatility and the complexity of returns.