Morningstar - Winter 2019 - 58

Investors

a company, there are operational levers that may
be able to generate return nonetheless.
Huckstep: We've regressed the historical returns
of the equity of firms that work in commodities
markets against both commodity returns
and broad stock market returns. We've found that
these companies tend to exhibit a high
correlation with commodity returns and a lesser
correlation with stock market returns. They're
not a perfect hedge, they're not as good
as a physical commodity in that sense, but they're
still pretty good. We sometimes have
more positive return expectations for those types
of investments, and you still get some of the
correlation benefit.
Benz: That leads to the role of commodities in portfolios.

What do they add to the risk/return profile?

Huckstep: There has been a significant change
to the commodities markets. Between 1970
and 2007, liquid commodity investments produced
double-digit returns. Since 2008, returns have
been negative. Our group forecasts long-term
returns for commodities, and prior to 2008, we saw
positive collateral returns, positive roll yield,
and positive spot price impact. Those are three
components of returns of liquid commodities.

The price of gold is what the market will bear.
The price of gold was above $1,900 a decade ago,
and now it's below $1,500, so you lost 25%.
But liquid commodities are a little bit different.
Futures have exposure to three different
components. The spot price is easy to understand.
If prices go up for the physical commodity,
you typically have a positive return. But the two
other components are important. If you invest
in a liquid commodities fund, the portfolio
manager typically invests it in a collateral, usually
a Treasury bond. So, you also suffer duration risk.
Roll yield is the third component. In futures
markets, you make a deal to buy a commodity in
the future, and that price for that commodity
can either be higher or lower than what it is today.
Before 2008, the majority of commodities
futures had positive roll yield. Now, roll yield
is negative for most liquid commodity investments,
and it's prudent to consider that. When we

58

Morningstar Winter 2019

	
While equities offer leverage
to commodity prices, you're also taking
on company-specific risk.
Kristoffer Inton

talk about what to expect from commodities going
forward and what they add to the portfolio,
one of the most important things to consider is the
expected return. And today, our group is
still forecasting lackluster expected returns.
Of course, you get the benefit of lower
correlations with stocks and bonds. It's like buying
fire insurance on your home. Your home may
never burn down, but was it the wrong decision
to buy that insurance? That's why we see
some multi-asset portfolio managers allocating a
little bit to commodities, even with the expectation
that returns may be subpar.

Benz: Jeff, increasingly, investors get their exposure
to energy stocks by simply buying a total market
index fund. Is that a legitimate way to obtain exposure
to the sector or should it be considered separately?

Stafford: I do think that's a legitimate way to get
exposure to the energy sector. But energy
as a percentage of the S&P 500 is down to around
5% today, whereas 10 years ago it was close
to 15%. A lot of that has to do with oil prices.

Most of that share comes from the large, major oil
producers and refiners, such as Exxon Mobil XOM
and Chevron CVX. They're integrated players
so are fairly representative of the energy space.
Morningstar - Winter 2019

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