Impact of falling oil prices on Russell Investments’ managed accounts
Oil prices have taken a battering so far this year. In the first quarter, prices slumped almost 67%1 on fears a new price war between major producers Saudi Arabia and Russia would see supply spike at a time when demand was falling. In April, prices fell a further 8% even as the Organisation of the Petroleum Exporting Countries (OPEC) and its allies agreed to cut output by 9.7 million barrels a day – the largest production cut on record. In fact, we even saw prices turn negative for the first time, with producers paying buyers to take oil off their hands amid concerns they would run out of room to store it.
We saw all of this play out in the news headlines and advice for our regional strategist and commodities portfolio manager was to look beyond the recent headlines related to short-term oil prices trading close to zero. With this in mind, let’s look beyond the headlines and take a deeper dive into the impact of lower oil prices on Russell Investments’ managed accounts.
We know that commodities can play an important diversification role in a multi-asset portfolio. But they also benefit from increasing demand and act as a hedge, or protection, against rising inflation; neither of which are compelling reasons to hold direct exposures to commodities in the short-term.
The allocation to direct commodities within Russell Investments’ managed accounts is near zero. This means investors have avoided direct losses associated with falling commodity prices, including oil. In fact, the last time our managed accounts’ core dynamic real return strategies had a material exposure to commodities was mid-2018. That was when we started to aggressively trim our commodities exposure in response to the escalating trade war between the US and China.
But whilst our managed accounts may have little direct exposure to commodities, they do have allocations to some assets indirectly affected by falling oil prices, including high-yield debt. High-yield debt investors lend to companies with less favourable, or sub-investment-grade, credit ratings in return for higher potential income and returns. The high-yield debt market has struggled of late due to the impact that lower oil prices have had on borrowers within the energy sector.
In the past two years, our managed accounts’ core dynamic real return strategies have held low levels of high-yield debt in favour of a greater allocation to higher-quality, investment-grade debt. This was based on our view that high-yield debt had become too expensive. However, in March, we started to add to our high-yield debt exposure as valuations improved significantly in the wake of a sharp selloff in credit markets; a selloff driven by fears of a coronavirus-induced global credit crunch. Our fixed income team discusses our renewed, high conviction in high-yield debt in more detail here.
Whilst the collapse in oil prices has obviously caused much uncertainty in financial markets, it’s important that investors focus on their specific asset allocations and not get sidetracked by sensational headlines. The kind of oil price volatility we’ve seen in recent months will often have direct and/or indirect implications for investors. Moving forward, our managed accounts maintain an indirect allocation to commodities via our high-yield debt exposure, while our allocation to direct commodities remains close to zero.
1West Texas Intermediate crude oil