Balancing Risk While Reaching for Yield | Blog

Yield starved investors are increasingly stretching for mere basis points, and investors looking for additional yield will likely need to take on more portfolio risk. 

In times like these a proper understanding of portfolio diversification is essential. 

Investment selections should be made with an eye on one’s entire portfolio. It is cliché at this point, but diversification is key. The potential benefits from portfolio diversification rely on the tendency for some investments to zig when others zag. Looking back and observing which holdings zigged while others zagged, and (critically) the magnitude of those zigs and zags, an investor can begin to understand the correlation[1] between specific holdings. This knowledge allows an investor to measure a single holding’s overall impact on portfolio volatility. 

Currently the S&P 500 has an approximate dividend yield of 1.6% which is more than 1% higher versus the 10 Year Treasury Bond. Stocks, therefore, might be a reasonable alternative to bonds for investors looking for income. Stocks of course are more volatile than bonds and increasing an allocation to stocks will likely increase portfolio volatility. As such, it may be prudent to simultaneously seek out investments that historically have low correlations to stocks.

This search often leads to alternative investments such as commodities.

As an asset class, commodities are less volatile than stocks.[2] However, the fundamentals impacting the prices of specific commodities vary within the asset class. Some, like oil, are closely tied to economic expansion whereas gold is more closely tied to currency markets. The price of grains, such as corn, wheat, and soybeans, are largely dependent on weather. With this understanding it becomes important to recognize the distinct attributes and potential benefits various commodities can add to a portfolio. Here investors may turn to history for guidance.

While past performance does not guarantee future results, an investor can observe how various commodities performed during different markets. 

Consider that the S&P GSCI Grains Index has outperformed the S&P 500 in 10 out of the last 11 stock market corrections of 10% or more (figure 1). This suggests that historically, an allocation to grains has helped soften the blow when equity prices head lower. 

Figure 1:

Consider too the low historical correlations between the prices of grains (i.e. wheat, corn, and soybeans) and the stock market (figure 2). Low correlations reflect the tendency for prices to move independently one each other.

Figure 2:

Alternative investments such as commodities, specifically grains, may hold an increasingly important role in a diversified portfolio moving forward. In fact, this trend may already be well underway. Teucrium, as you may know, only issues agricultural ETFs and according to Bloomberg, Teucrium has led the ETF market as the fastest growing issuer in two of the last four weeks[3]. 

A weaker US Dollar may also be a contributing factor as a lower Dollar has historically been a tailwind for commodity prices. For more on the Dollar’s impact on grains please read our blog: Dollar Weakness : Think Grains – found here https://teucrium.com/news-insights/158

While commodity investments typically do not provide income, they may be increasingly paired with income producing investments given their low historical correlations to equities. This low correlation could help reduce overall risk in a properly diversified portfolio. 

[1] Correlation: A measure of how two securities move in the market in relation to one another, i.e.; in tandem or inversely.

[2] Comparing the standard deviation of the price return of the S&P 500 vs the Refinitiv Equal Weight Commodity index 12/31/1999 – 12/31/2019

[3] Source Bloomberg News: Data for weeks ending 06/26/2020 and 07/17/2020