Canadians are overly focused on investing in stocks of commodity-producing companies and are missing out on diversification by not investing in underlying raw materials.

Including “pure” commodities as a stand-alone asset class can enhance overall portfolio diversification, says Criterion Investments. That’s because commodity prices are historically uncorrelated to other asset classes, responding differently to economic and market conditions.

“Even though commodity-based companies make up almost half of the S&P/TSX composite Index, and energy makes up almost a third, Canadian investors are likely underexposed to pure commodities,” says Ian McPherson, president of Criterion.

Criterion points to studies showing that pure commodities can improve portfolio returns without increasing volatility. Ibbotson Associates concluded that a basket of diversified pure commodities should be a core portfolio component, with an optimal allocation of between 10-26%, subject to an investor’s risk tolerance.

“Stocks of commodity producers behave like general equities, with many similar company-specific risks such as cost overruns, royalty changes, management execution and political challenges etc. As well, exposure to the underlying raw material might be even further diluted since companies often hedge their commodity exposure,” McPherson says.

According to Criterion, an effective way to optimize commodity exposure is to invest in commodity futures. Previously the domain of the institutional sector, commodity futures are now accessible to Canadian retail investors.

With diversification in mind, Criterion chose to base its commodities solution on the Dow Jones AIG Commodity Index Total Return, comprised of 19 commodity futures spread across seven sectors. As well, Criterion Diversified Commodities Currency Hedged Fund recently adopted an enhanced strategy enabling it to select the most attractive futures contract within a nine-month time horizon for each commodity within the Index.

“For Canadians investing in commodities, currency hedging is vital,” says McPherson. “All commodities trade in U.S. dollars, which leaves investors exposed to a significant currency risk. Since the loonie is highly correlated to commodities, that currency risk can wipe out your returns.”

Criterion is an affiliate of VenGrowth Asset Management Inc.