Today's hot money is in commodities and emerging markets.
Nothing gets money managers to think outside the box like an economic crisis and an ensuing bear market. When what worked before doesn't work anymore, we all tend to look for new ways to get the job done. And, perhaps not surprisingly, fund managers with a global reach are turning to two sectors of the market that have been on fire lately.
Follow The Money
According to the a US survey of fund managers, commodities and emerging markets are the "must have" investments for the new year. The survey revealed that a net 25% of global managers are overweight in commodities, while 53% are overweight in emerging markets.
These numbers are up from 11% and 46%, respectively, in October. Fears of rising inflation are part of the motivation behind the move to these sectors, as managers seek to proactively hedge that risk.
Of course, the tremendous returns that these two areas of the market have posted in recent years may also add to their allure. Commodities have been on a tear lately, as nervous investors look for low-correlation asset classes that can provide diversification and, hopefully, juicier returns. Silver miner Fresnillo (LSE: FRES) is up a stunning 767% in the past year, whilst gold miner Randgold Resources (LSE: RRS) has jumped 147%.
Likewise, emerging markets appear to be pulling out of the global recession ahead of the US and UK, so money has been flowing into developing economies fast and furiously. Since this time last year, the US-dollar denominated MSCI Emerging Markets Index has almost doubled, marking a windfall for investors in foreign shares.
Buy High?
While the increased attention on commodities and emerging markets is not surprising, investors would do well to think first before blindly throwing their lot in with these corners of the market.
In the wake of the recent bear market, everyone is looking for the next sure thing to recoup some of their losses, but chasing hot recent performance is not the ticket. True, commodities and emerging markets have done well recently, but that doesn't necessarily mean that they will continue to do as well in the future.
While many investors are lured by the outsized returns these sectors have posted, it's important to remember that with big returns comes big risk. Commodities and emerging markets are two of the most risky and volatile asset classes around. For example, while emerging markets are up strongly this year, they also lost over 50% last year. Likewise, crude oil recently fell from $147 all the way back to $30 a barrel not too long ago.
The Better Bet
Ultimately, I think there is a better case to be made for investing in emerging markets than in commodities. Looking forward to the next decade, odds are pretty good that emerging markets will outpace the domestic economy, as well as developed foreign economies.
Some of the greatest growth prospects in the entire globe lie in emerging economies like China and India, as well as smaller 'frontier' economies like Vietnam, Peru and Qatar. So while volatility will always be a concern in this space, even more conservative investors should have at least a minimal exposure to emerging markets to capture the gains these areas are likely to generate.
I'm slightly less optimistic about commodities. While it may make sense to buy solid, individual commodity-related shares with good long-term prospects, owning specific commodity-focused funds may not be a winning move over the long-run.
Academic research has shown that commodities can further diversify an investor's portfolio. However, in general, they are not good long-term wealth builders. For example, while its inflation-fighting powers are frequently cited as reasons to hold gold, this metal hasn't been able to keep up with the returns of stocks over a long time period. Despite their ups and downs, shares are still better return-generators over the long run than most commodities.
Slow And Steady Wins The Race
Remember, following hot money isn't likely to pay off in the long run, but investing strategically in sectors with meaningful potential will. There's a world of investment opportunity out there to be had in the coming years -- if you know where to look.
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> A version of this article was originally published on Fool.com. It has been updated by Bruce Jackson.
