Given current valuations, investors who belong to Generation Z – born after 1996 – can expect a standard portfolio of stocks and bonds to produce only about a 3 per cent annual real return in the years ahead, according to projections by the Credit Suisse team.ALEXANDER MANZYUK/Reuters
If your broker is pitching you on the idea of investing in commodities, you should pay close attention to the tables buried deep in the 2023 edition of the Credit Suisse Global Investment Returns Yearbook.
The influential and wide-ranging annual guide to markets was published on Thursday. It provides exhaustive detail on many topics, including why you should not make a habit of investing in individual physical commodities.
The yearbook shows, for instance, that an investor who began buying cotton, corn, copper or sugar in 1900 would have gone on to lose money in real terms over the next 123 years.
Nickel, the best performer among 29 major commodities studied, produced an average real return of only 1.2 per cent a year over this multi-generational period. It edged out gold, which generated an average real return of just 0.76 per cent a year.
Given those dismal results, is there still any case to be made for holding commodities? Surprisingly, there is, according to Elroy Dimson, Paul Marsh and Mike Staunton, the three British academics behind the yearbook.
One key to generating better returns, according to the yearbook authors, is buying commodity futures, not physical commodities. Futures are essentially contracts to purchase a given quantity of a commodity at a future data at a fixed price. The contracts are usually sold before delivery day, making them a convenient way for an investor to bet on the price of a raw material without having to worry about actually taking possession of the physical good.
Another key to profits is broad diversification. Many commodities suffer from wild volatility in their prices. Those swings in price hurt returns. On an individual basis, 21 out of the 29 commodities studied by the Credit Suisse team lost money for investors between 1900 and 2022.
But commodities don’t all move together. A portfolio that held equal amounts of all these commodities would have historically generated a positive return by offsetting the steady drip of losses from most commodities with big gains on the handful of commodities that were spiking at any given time.
The yearbook crew concludes that constructing an equally weighted portfolio of futures on many different commodities could have succeeded in buffering an investor against inflation while delivering an attractive return of about 3 per cent a year over holding cash.
“Inflation hurts returns from bonds, stocks and real estate,” Prof. Marsh of London Business School told an online audience at the launch of the yearbook. “In contrast, commodities – especially commodity futures – can offer a hedge against inflation.”
Unfortunately, the practical obstacles to achieving that profitable inflation hedge seem rather large. For one thing, commodity markets are limited in the amount of investment they can handle. If everyone attempted to increase their exposure to commodities, there would be problems, the yearbook authors note.
For another thing, most commodity indexes are not equally weighted. Instead, they tend to hold commodities in proportion to their production volumes or other factors. It’s no great surprise, therefore, that exchange-traded funds based on them have been lacklustre performers over the past decade.
Maybe the best way to view the yearbook’s excitement over commodities is as an admission that prospective returns on more mainstream investments aren’t looking so great.
Younger investors are likely to reap portfolio returns only about half as large as their baby boomer predecessors, according to the Credit Suisse team.
Given current valuations, investors who belong to Generation Z – that is, born after 1996 – can expect a standard portfolio of stocks and bonds to produce only about a 3 per cent annual real return in the years ahead, according to projections by the Credit Suisse team.
In contrast, baby boomers (born from 1946 to 1964, the yearbook says) have enjoyed a 5.6 per cent annual real return from a standard stock-and-bond portfolio.
The big decline in the prospective rewards from investing in the two major asset classes shows why eyes are turning to other assets – such as commodities – to fill the gap. The challenge will be finding ways to make such diversification easy and practical.