Commodities offer hedge against inflation

Commodities are the only major asset class to provide a hedge against inflation, new research by London Business School (LBS) experts Professor Paul Marsh and Dr Mike Staunton and LBS alum Professor Elroy Dimson confirms.

But these same inflation-hedging properties also mean commodities tend to underperform in extended periods of disinflation.

The researchers’ analysis, detailed in the Credit Suisse Global Investment Returns Yearbook 2023, also shows that:

• Based on historical returns, it seems reasonable to assume that a balanced portfolio of collateralised commodity futures is likely to provide an annualised long-run future risk premium of around 3%.
• The investable commodity futures market size is quite small. Thus, while individual investors or institutions may wish to consider increasing their exposure to these assets, large increases would be challenging if everyone sought to raise their allocations.
• An initial investment in gold (often seen not just as a commodity, but also a financial and cautionary investment) of USD 1 in 1900 yielded a real terminal value of USD 2.5 by end-2022. This compares poorly with US bonds and stocks, which gave terminal values of USD 7.8 and USD 2,024. It does, however, have a role as an inflation hedge.

Now in its 15th edition, the Yearbook is the authoritative guide to historical long-run returns. Published by the Credit Suisse Research Institute in collaboration with London Business School, it now covers all the main asset categories in 35 countries. Most of these markets, as well as the 90-country world index, have 123 years of data since 1900.

The 2023 Yearbook also demonstrates:

• Equities have performed best over the long-run. Over the last 123 years, global equities have provided an annualised real USD return of 5% versus 1.7% for government bonds and 0.4% for Treasury bills.
• Equities have outperformed bonds, bills and inflation in all 35 markets. Since 1900, world equities outperformed bills by 4.6% per year and bonds by 3.3% per year.
• The recent strong uptick in inflation has reminded investors about the likely impact of inflation on asset returns. For bonds, the impact is clear. Conventional fixed income bonds have cash flows that are contractually fixed in nominal terms. When inflation rises, interest rates will also tend to rise and the price of fixed income securities will fall.
• For both equities and bonds, real returns tend to be higher when economic growth is higher and inflation is lower. In times of stagflation, real equity returns averaged −4.7% while the average real bond return was −9.0%. In the opposite case of stable growth, the average real returns were +15.1% for equities and +8.8% for bonds.

Professor Marsh said: “In periods of economic uncertainty, it can be easy to lose perspective of the long term investment horizon. The Yearbook, with its database stretching back 123 years, provides a rich source of information and experience to help readers navigate their investment strategy for the future by learning from the past.”

A summary of the Global Investment Returns Yearbook 2023 is available online.