The coming year marks a difficult one in which to decide the likeliest outperformer among the alternative asset classes. The rise in interest rates could offer a problem for private credit, while private equity might struggle given pricey equity valuations. Real estate also looks well valued.

With this in mind we asked the following question for the coming Chinese New Year:

Which will be the best-performing alternative asset class on a risk-adjusted basis?

Answer: Commodities

Commodities have been shunned by investors in recent times — and it is easy to see why. They represent the worst-performing of 12 major asset classes identified by Pimco every year bar one since 2011, according to research published by the US fund house in late January. 

The Bloomberg Commodity Total Return Index posted negative returns from 2011 to 2015, before gaining 11.77% in 2016. It then rose by just 1.7% last year, when global equities returned 22.4%. 

Yet some experts believe commodities are set for a renaissance — and AsianInvestor agrees. At a time when most alternative and traditional investments look richly valued, there are good reasons to think the Earth Dog will be a commodities year.

Energy and metal prices are up since the start of 2016 and rose particularly strongly in the second half of 2017. Subsequent capital inflows pushed commodity assets under management to a four-year high of $311 billion at the end of 2017, according to UK bank Barclays.

Admittedly, commodity prices are not generally expected to perform quite as well this year. The World Bank predicts that energy prices — be it for oil, natural gas, or coal — will climb 4% this year after a 28% leap in 2017. It forecasts the metals index to be largely flat after a 22% jump. 

Importantly, though, investors don’t see a lot of downside for commodities.

The global economic environment is widely viewed as favourable. Indeed Jeffrey Currie, global head of commodities research at Goldman Sachs, said in January it was the best macro backdrop for the asset class since 2004. In December his team forecast a 10% return for commodities for the coming year. 

Both Currie and bond veteran Jeffrey Gundlach of Doubleline Capital have also tipped commodities to outperform stocks in 2018, and both are especially bullish on metals.

Commodities are a traditional hedge against inflation, which many investment professionals expect to finally march upwards in the US and elsewhere this year.

All this being said, the US dollar is a key factor. If it stays low or depreciates further from here, then commodities — which are generally priced in the American currency — would gain a further boost. Of course, there is no guarantee of that, despite US President Donald Trump’s current weak-dollar policy. 

If we assume the commodity sector is a good place to be, what’s the best way to play it this year? 

Futures or exchange-traded funds can provide exposure to individual commodities but taking such concentrated bets may not be the best approach now. This is because many analysts, including those at the World Bank, argue that commodity prices are likely to only rise a little or to stabilise this year after robust gains in 2017. 

Buying mining or energy company shares is a better strategy, say portfolio managers, on the basis that they expect to see successive upgrades to their past earnings levels this year, as higher commodity prices are reflected in analysts’ profit estimates.

Commodity-related real assets are also worth a look, say some, in light of a growing number of attractive co-investment opportunities through private market investment firms. 

Previous Year of the Dog predictions:

Will there be any post-election regime changes in Southeast Asia?

Will China's debt burden become a major drag on the economy?

Will Bank of Japan's quest to create inflation succeed 

​Are European and UK securities a good bet this year?

Will the US Treasury yield curve invert?

Will Donald Trump still be president at the end of 2018?

What will be the best performing asset class, on a risk-adjusted basis?