In the current market environment, it can be difficult to know where to turn. With daily headlines reminding us that the equity market rally won’t last forever, but government bond yields are still at relative lows, it’s time for advisors to think outside the box in their asset allocation strategy.

Depending on your clients’ investing goals, the long-term growth prospects of natural resources may be worth another look. Not only can natural resources enhance portfolio diversification, but they can offer an attractive way to take advantage of global growth and potentially combat inflation. We believe the value proposition for natural resources over the long-term is strong. (For related reading, see: 10 Countries With the Most Natural Resources.)

Consider International Growth

As the global economy continues to strengthen, with all 45 countries tracked by the Organisation for Economic Co-operation and Development (OECD) set to grow this year, we believe that investments in natural resources could be an effective way to capitalize on economic expansion. The categories that fall within natural resources - energy, agricultural products, metals, timber and water - are the building blocks of a developing economy and a key foundation for growth.

With countries like China, India and other emerging markets experiencing high levels of population growth and urbanization, the potential increased demand for natural resources over the long-term is clear. For example, China could spend $950 billion a year on infrastructure projects, such as its One Belt, One Road (OBOR) initiative, while India is expected to expand its manufacturing share of gross domestic product (GDP) from 17% to 25% in the next 10 years - both requiring the energy and the raw materials to make this possible.

In 2017 alone, with a positive global outlook infiltrating throughout the market, natural resources segments have rallied, with metals like copper surging 48% and oil prices reaching their highest level in the past two years. Even considering the risks faced by the global natural resource industry, including geopolitical events and economic conditions, investors who choose a diversified natural resource investment may still benefit.  

Mitigate Inflation Risk

In addition to the potential international growth benefits, natural resource investments are often considered an effective way to mitigate inflation risk. This is because when an economy heats up, demand for consumer goods increases, creating a rise in the price of raw materials. Though it may seem that it would be going against the consensus to explore investments positively correlated to inflation, given that inflation is currently muted in the U.S. and eurozone, there are signs that capacity pressures or “slack” in the labor market may be giving way and may lead to eventual wage and price growth.

Given that the Fed recently approved a quarter-point hike at its December meeting, this may mean that the Fed is anticipating an uptick in inflation expectations, however modest in the short-term. As such, we believe investors may want to consider natural resource investments which historically are a component of the Consumer Price Index (CPI), the key indicator for inflation. (For related reading, see: Natural Resources ETF: IGE or GNR?)

Optimize Your Exposure to Natural Resources

When researching natural resources investments, it’s important to remember that not all options are created equal. Advisors have many potential investing options - from direct investments in commodities to commodity-tracking exchange-traded funds (ETFs) - each with their associated benefits and risks.

We believe that a key consideration for investors is the distinction between the upstream and downstream components of the natural resource supply chain. It’s worth considering how natural resource equity ETFs may be impacted by each step in the supply chain. Whether funds are focused on the “upstream” segment of the market - investing in companies that handle natural resources in the extraction phase - or the “downstream” portion, which deals with finished products, can make a difference. An upstream focus offers investors profitability from raw materials price increases, which we view as a likely possibility in today’s global growth environment, while equities involved in the downstream segment may be hurt by rising input costs to finished products.

Within ETFs that track natural resources equities, there are also many factors advisors should be aware of. For example, advisors should consider the extent to which their natural resources ETFs are diversified. Particularly if your client is interested in managing risk, you may want to choose funds with exposure outside the historical segmentation of energy and metals, to consider water and timber, which may help minimize overexposure to any one area.

Given today’s market uncertainty, advisors may want to consider investments with a solid, long-term foundation like natural resources. We’ve already begun to see how positive global growth projections can impact the commodities market, and we expect ongoing development in emerging markets to add to this trend in the coming years. For a simple, cost-effective investment, natural resources ETFs may be worth adding to your clients’ portfolios. (For more from Flexshares, see: 3 Investment Options for Changing Levels of Inflation.)

 

Disclosure: Before investing, carefully consider the FlexShares investment objectives, risks, charges and expenses. This and other information is in the prospectus and a summary prospectus, copies of which may be obtained by visiting www.flexshares.com. Read the prospectus carefully before you invest. Foreside Fund Services, LLC, distributor.

An investment in FlexShares is subject to numerous risks, including possible loss of principal. Fund returns may not match the return of the respective indexes. The Funds are subject to the following principal risks: asset class; commodity; concentration; counterparty; currency; derivatives; dividend; emerging markets; equity securities; fluctuation of yield; foreign securities; geographic; income; industry concentration; inflation-protected securities; infrastructure-related companies; interest rate / maturity risk; issuer; large cap; management; market; market trading; mid cap stock; MLP; momentum; natural resources; new funds; non-diversification; passive investment; privatization; small cap stock; tracking error; value investing; and volatility risk. A full description of risks is in the prospectus.

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