Commodities are a major asset class that many UK investors lack exposure to. Here, we discuss the benefits of investing in commodities as part of a diversified approach, such as that offered by the Winton Absolute Return Futures Fund.

Investing in futures

Investing in commodities allows savers to profit from price changes in the raw materials that underpin the global economy. The asset class – which includes energies, base metals, precious metals, crops and livestock – consists of a range of markets whose supply and demand dynamics differ. The figure below details the breadth of commodities markets available, by showing the 43 currently traded in the Winton Absolute Return Futures Fund.

Rather than buying or selling the physical commodity, investment managers such as Winton gain exposure to these markets through exchange-traded futures contracts, which converge to the price of the underlying commodity at maturity. These contracts make it easy to open and close positions. They also provide more direct exposure to changes in commodity prices than, say, buying the shares of an oil major or mining company.

Commodity markets traded by the Winton Absolute Return Futures Fund

Source: Winton, as at 25 October 2019.

Material improvement to portfolio diversification

The diverse nature of commodity markets means that their returns tend to vary from one another. The heatmap below shows how correlations between average commodity sector returns have been close to zero over the past 20 years. Commodities have also historically had low correlations with equities and bonds, which makes them a valuable source of diversification.

Low long-term correlations between commodity sectors, equities and bonds

Source: Winton, as at 25 October 2019. Shows the 20-year correlation between the average 20-day returns of five commodity sectors, equities and bonds, calculated using daily back-adjusted futures returns.

These diversification benefits are apparent in Winton’s portfolios. The figure below shows the calendar-year performance by sector for Winton’s systematic multi-asset strategy since 1997, ranked from most profitable to least profitable. In a given year, the strategy made money in the sectors that fall above the white line. As the figure shows, no one sector has consistently delivered positive returns, which demonstrates the importance of applying the strategy to multiple asset classes.

Overall, Winton’s strategy has made money in commodities in 16 out of 22 calendar years since it started trading. These positive contributions have been particularly valuable at times. For example, profits in commodity markets mostly offset the Winton Absolute Return Futures Fund’s losses in currencies and equity indices during 2018. This broader investment universe has also enabled Winton’s investors to profit from some major investment opportunities outside of equities and bonds – such as the rally in gold prices after the 2008 financial crisis and the collapse in the oil market during 2014 and 2015.

Room to grow

The number of commodities traded by the Winton Absolute Return Futures Fund has increased from five at inception in July 2017 to 43 today, following the addition of carbon credits, iron ore and Dutch natural gas in September this year. Winton continues to seek out new markets to add to its portfolios and this number could increase further, providing investors in the fund with exposure to an even larger number of investment themes.