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Historical Natural Resources & Commodities Investing – Post COVID-19 Crisis

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Investors have long turned to commodity and natural resource investing as a potential source of diversification, inflation hedging, and capital appreciation. However, commodities—and notably natural resources—are currently slightly out of favor with investors. Is this market sentiment here to stay?

On a recent episode of our Funds in Focus podcast, we spoke with Senior Investment Strategist Mark Carlson about how commodities investing has changed over time, how it has come to be out of favor with investors, and whether it could be poised for a rebound.

In this episode, you'll learn

  • Some background on investing in natural resources and commodities
  • How investing in commodities has changed over time
  • The differences between investing in upstream natural resource equities and commodity futures investing
  • What sectors within natural resources may be the primary drivers of these investment outcomes that may evolve in the post-COVID-19 world

COMMODITY FUTURES INVESTING HAS ITS DRAWBACKS

From the early days of trading, commodity futures were the go-to vehicle for commodities investing. However, as access to commodities futures became easier through investing tools such as exchange-traded notes (ETNs) and more investors used them for core allocations, correlations rose between commodities futures and equities. In effect, diversification benefits diminished.

The structure of commodities futures contracts can also make them problematic for long-term strategic allocations. This is because investors must continually roll from expiring futures contracts into longer contracts to maintain the allocation. And if the price of the longer contract is higher than the spot price, then the investor must reinvest in the futures contract at a higher price. This is known as negative roll yield, which can effectively erode returns.

NATURAL RESOURCE EQUITIES CAN BE A SOLUTION—BUT THE INDEX MATTERS

Unlike commodities futures contracts, natural resource equity investments don’t run the risk of negative roll yield. They have also historically benefited from compensation for the equity risk premium and can generate income through dividend distributions. Further, natural resource equities and can offer the opportunity for broader, more diverse exposure to natural resources where futures are not available.

However, one of the historical drawbacks of natural resource equities is that some legacy indices often provide inefficient sector exposure and may have weaker than expected correlations to inflation. And because these indices have long performance track records, many investors continue to use them. Newer natural resource indices—like the Morningstar Global Upstream Natural Resource Index—can correct for these shortcomings.

COMMODITIES AND NATURAL RESOURCES ARE OUT OF FAVOR—BUT THE INDEX STILL MATTERS

As the COVID-19 crisis roiled markets, both commodity futures index and natural resource equity performance plummeted, taking a harder hit than broader equity markets. Global lockdowns at the onset of the crisis—and again being imposed as we’ve seen a resurgence of cases—stifled demand, particularly in the energy sector. And since commodities and natural resources tend to thrive in a fully employed and globalized economy, they continue to be out of favor with investors as the pandemic crisis and its economic impacts persist.

But while commodities and natural resources equity returns were negative across the board, year-to-date through July 2020 they varied across indices. We also observe variation across 5-year annualized returns, underscoring why commodities and natural resources index selection matters.

Index total returns for the period ending 7/31/20

 

YTD total returns

5-year annualized returns

FlexShares Morningstar® Global Upstream Natural Resources Index Fund (GUNR)

-11.4%

4.7%

Morningstar Global Upstream Natural Resources Index

-11.0%

5.1%

S&P Global Natural Resources Index

-16.3%

3.1%

Bloomberg Commodity Total Return Index

-14.8%

4.5%


Performance data quoted represents past performance and does not guarantee future results. Investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed or sold in the secondary market, may be worth more or less than the original cost. Investors will incur usual and customary brokerage commissions when buying or selling shares of the exchange-traded funds ("ETFs") in the secondary market, and that, if reflected, the brokerage commissions would reduce the performance returns. Current performance may be lower or higher than the performance shown. For the most recent month-end performance, please visit the Fund's website at www.flexshares.com or call 855-353-9383 for more information.


CAN THE SECTOR STAGE A COMEBACK?

There are many uncertainties when it comes to what the post-COVID-19 world looks like and how it will impact commodities and natural resources demand. Some of it hinges on China’s economic recovery, as the country is the largest consumer of most industrial metals. If China can continue its progress toward a more developed economy, this would drive higher demand for commodities.

The pandemic has given rise to increased work from home lifestyles, which could impact commercial real estate and in effect construction materials. More time spent at home could also continue to cut into demand for energy.

However, while the end date of the crisis remains unknown, US and global economies will ultimately recover and demand for raw materials should return. And should historical trends continue, commodities and natural resources could continue to offer the potential for income, inflation hedging, and capital appreciation.

Please see our FlexShares Morningstar® Global Upstream Natural Resources Index Fund (GUNR) for more information on our global upstream natural resources ETF, including the most recent month-end and quarter-end performance.

IMPORTANT INFORMATION 

FlexShares Morningstar® Global Upstream Natural Resources Index Fund (GUNR) is subject to the global natural resource industry. As the demand for or prices of natural resources increase, the Fund's equity investment generally would be expected to also increase. Conversely, declines in demand for or prices of natural resources generally would be expected to cause declines in value of such equity securities. Such declines may occur quickly and without warning and may negatively impact your investment in the Fund.

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