Commodity Blues

For the firm’s more aggressive portfolios, Self recommends a 5% tactical allocation to energy, even though the sector has been slammed over the last year. “We believe global demand will absorb supply sooner than many people think, and that prices will go up quickly when that happens,” he says.

Financial advisors sitting on the commodity sidelines hoping to time a perfect re-entry point are playing a losing game, he adds. “The question you have to ask is when you’re going to get back into commodities,” he says. “By the time you realize it’s a good idea, it may be too late.”

Craig Ferrantino
Craig James Financial Services
Like Self, Ferrantino is hanging tough with client allocations to commodity ETFs by keeping them at around 5% to 10% of assets. But he prefers targeted exposure to specific commodity ETFs such as the SPDR Gold Shares fund instead of broad-basket commodity ETFs.

“Certain dominant sectors of the broad basket ETFs, such as energy, have taken an especially hard hit,” he says. “I think there is also a perception that gold is a store of value. And a lot of people are better prepared to sit through the volatility because they’ve seen gold prices move higher in the past.” To get exposure to the energy sector, Ferrantino prefers the stocks of energy companies because they are less volatile than oil prices. “The main thing is getting clients to understand that there are going to be more boom and bust cycles with a commodity ETF than normal equities,” he says.

Chris McMahon
McMahon Financial Advisors
As a longtime resident of Pittsburgh, McMahon has seen how commodities can change the entire character of a region. “Years ago, Pittsburgh was a depressed steel town,” he says. “After the discovery of the Marcellus shale, people who used to sew their own clothes began getting $100,000 a month royalties on their land. Now, companies have cut back production because of low gas prices.”

Commodities have had an impact on client portfolios as well, albeit a small one. About eight years ago, McMahon’s firm began using commodity ETFs for diversification and inflation protection. The firm’s allocations range from 2% for conservative portfolios to 7% for the most aggressive ones, and the firm focuses on broad-basket offerings such as the United States Commodity Index Fund (USCI).

McMahon, who sees another 12 to 24 months of depressed commodity prices, intends to hang on to his current positioning. “Some investors might see this as an opportunity to buy commodity ETFs at lower prices. We’re asset allocators. We aren’t going to try and guess when commodities will start to explode.”
Several of these advisors say they prefer commodity exchange-traded notes over exchange-traded funds in taxable accounts. The latter vehicles use futures contracts and are organized as partnerships, so their tax treatment is fairly complicated and they generate a Schedule K-1 tax form. By contrast, exchange-traded notes, which are unsecured debt notes issued by banks that promise to provide the return of a specific index, are treated for tax purposes like regular stocks and bonds.