Reduce risk, hedge inflation and diversify your overall investment strategy

Commodities have received much media coverage over the past year, with prices rising as other asset classes falter. Investing in commodities within your portfolio may not only create exposure to different investment products, but can also help reduce risk, hedge inflation and diversify your overall investing strategy.

Commodities, like much else, are subject to the laws of supply and demand. When demand rises, as has been the case with gold over the past few years, the price rises. Stock market volatility and rising UK inflation have attracted a diverse mix of investors to this sector.

In October the Monetary Policy Committee (MPC) announced £75bn of new quantitative easing (QE) measures to help boost the faltering economy and free up the money markets. The stock market reacted positively to this news with mining and commodity stocks benefiting from the QE which filtered through to asset prices.

Safe havens preserve wealth
Commodities are physical assets. They include oil and gas, metals such as gold and silver, and so-called ‘soft’ commodities such as wheat, sugar and cocoa beans. They are often called ‘safe havens’ as they preserve wealth in a physical way.

The sector has little correlation with stock markets and currencies, which means if equity markets fall, the price of commodities won’t necessarily fall.

They tend to behave differently to conventional asset classes and can therefore be very useful for the purposes of diversification within an investment portfolio.

Viable way to access commodities
An investment fund that enables investors to access the sector and spread risk, with investors investing in a variety of commodities, is a passive fund incorporating Exchange Traded Funds (ETFs).

ETFs provide appropriate investors with the chance of buying whole indices in the same way as buying a share on the London Stock Exchange. In addition, they are eligible for inclusion within Individual Savings Accounts and do not attract any stamp duty.

Tracking the future price
Equity-based commodity ETFs invest in shares of commodity companies through an index such as the FTSE 100, whereas Exchange Traded Commodities (ETCs) are instruments that track the price of the commodity, or a basket of commodities.

They can either be physically backed by the commodity itself or use swaps with other financial institutions to provide the exposure.

Should the price of the commodity fall, so will the investment, as the ETF will simply track its performance. ETCs also allow investors to ‘short’ or ‘leverage’ their investment. Investors should be careful here, as these strategies involve high risk. Although there are potential gains to be made, there could be significant potential losses too.

With the incredible rise of emerging economies forecast over the coming years, the commodity markets may provide appropriate investors with a range of investment opportunities to enable them to grow their wealth over the longer term.

Investments in commodities are by their nature generally considered to be higher risk. The value of these investments and the income from them can go down as well as up and you may not get back your original investment. Past performance is not an indication of future performance. Tax benefits may vary as a result of statutory change and their value will depend on individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.