During a volatile year for investors, sources of alpha – specifically uncorrelated alpha – were hard to find and harder still to maintain. Most major indices fell in value last year, with the MSCI World down -9.90%, the Nasdaq Composite index down -25.15% and the Bloomberg Global Aggregate GBP Hedged down -12.15%.
In previous bouts of weakness in bonds and equities, investors have tended to turn to alternative exposure for uncorrelated returns. However, many have exhibited double-digit negative returns. For example, the iShares UK Property UCITS ETF (IUKP) was down -33.81% in 2022 and its American counterpart fell 18.05%.
This has been spurred on by demand-side weakness as rate hiking cycles have increased the marginal cost of debt finance and mortgages above tolerable levels. This, coupled with higher input costs for homebuilders and servicing agents has led to weakness in the sector.
In these above conditions, commodity – and commodity proxy – exposure may not have seemed the inherent trade to make. Relentless US dollar strength, interest rate hiking cycles and recessionary worries have impacted various commodity sub-sectors sensitive to these inputs. However, price support has come from ongoing geopolitical risk exacerbating existing supply-side inefficiencies, a hangover from acute underinvestment during the pandemic.
Persistently high inflation readings have provided further support. This has led to a large dispersion of returns within commodities, requiring discretion and conviction when determining asset allocation. When we look at the performance of our positioning within this asset class, consistent sources of alpha emerge that added to the portfolio level performance in 2022.
As shown in the chart, all four of our main commodity or commodity proxy positions outperformed the shown equity and bond benchmarks in 2022. Our position in US midstream energy companies returned 36.13%, our enhanced commodity swap up 30.51%, physical gold 11.78% and the higher-beta equity proxy of gold miners up a modest 3.26%.
In comparison to benchmark returns, this represents consistent outperformance, with our exposure to midstream US energy companies outperforming the MSCI World by over 46%.
Indeed, we believe the environment for continued outperformance for certain commodities is in place. This is specifically pertinent to our precious metals allocation. While gold has outperformed certain equity and bond indices, we do not believe the yellow metal has realised its full potential this cycle.
A strong US dollar and rising global interest rates have capped price appreciation and flows into alternative supposed safe-havens such as crypto-currency have, until recently, proven more attractive.
We retain a cautious view on equities and see further relative upside for precious metals. With peak inflation, the growing recessionary narrative and softening rhetoric from Fed chair Jerome Powell, we think gold has room to run over the course of 2023.
As views on peak US interest rates have softened, we have seen a bottoming of the 10-year Bloomberg Inflation Swap real rate index, which moves inversely to future interest rate expectations. Given the historic correlation to gold, a continuation of this narrative should pave the way for further gold appreciation next year.
Compounding this, behind 1967, this is the second-largest year for central bank gold buying. With this increased engagement from institutions, ongoing geopolitical turmoil and the rhetoric surrounding hiking cycles, we believe gold continues to play an important role in prudent risk management, and currently, there is a strong fundamental case for holding gold in a balanced portfolio.
Jonah Levy is portfolio manager – physicals at Titan Asset Management
This article first appeared in ETF Insider, ETF Stream's monthly ETF magazine for professional investors in Europe. To access the full issue, click here.
Disclaimer: Titan Asset Management Limited is authorised and regulated by the Financial Conduct Authority. Titan Asset Management Limited is a wholly owned subsidiary of Titan Wealth Holdings Limited. This content is for financial intermediaries, it is not aimed at the general public. This document is published and provided for informational purposes only. The information contained within constitutes the author’s own opinions. Titan Asset Management Limited does not provide financial advice. None of the information contained in the document constitutes a recommendation that any particular investment strategy is suitable for any specific person.