Knowing what’s in an exchange-traded fund is usually as easy as clicking a button, since the funds are transparent about their daily holdings. But understanding the fund’s investment strategy is an entirely different ball game.
That’s especially true with commodity ETFs, which come in a variety of packages, each one unique.
With inflation stubbornly elevated and U.S. interest rates likely to remain stubbornly high, commodities have delivered impressive returns this year, beating bonds and real estate.
“Broad commodities, more than any single commodity, have a high correlation to inflation. Historically they've been a great inflation hedge,” said John Love, the CEO at USCF Investments. “You saw what you’d expect in this last inflation cycle with broad commodities rising hand and hand with inflation as it went up.”
So with commodities up, the ETFs that cover them have gotten a natural boost as well, and investors’ interest in them is on the upswing. In fact, the top 20 commodity funds by assets under management vacuumed in almost $1 billion in April alone, according to Bloomberg Intelligence (together these funds oversee around $20 billion).
Among the oldest and largest of the diversified commodity ETFs is the Invesco DB Commodity Index Tracking Fund (DBC). Launched in 2006, it has almost $1.8 billion in assets, and it’s linked to the DBIQ Optimum Yield Diversified Commodity Index. It tracks 14 commodities, though it’s tilted heavily to energy—almost 55% of it goes to things like crude oil, gasoline and natural gas. Agriculture and metals make up the rest. The fund’s annual expense ratio is 0.87%.
The iShares S&P GSCI Commodity-Indexed Trust (GSG) also debuted in 2006. This fund tracks the S&P GSCI, a world production-weighted commodity index on 24 futures contracts of physical commodities across five sectors: energy, industrial metals, precious metals, agriculture and livestock.
Every November the index provider indicates the commodity weightings for the upcoming year. And for 2024, the iShares fund’s index is roughly 61% energy and 18% agriculture while the remainder in in livestock, industrial commodities and precious metals. The GSG fund’s annual expense ratio is 0.75%.
Things Get Missed
The weakness of these two index-based funds is that they are rebalanced annually, which means they can miss certain commodities altogether or find themselves overweight in the wrong ones. They offer little flexibility for swift adjustments, which can make all the difference in fast-moving commodities markets.
Take cocoa. It’s been setting record highs, but it’s missing from most ETFs linked to standard commodities indexes. That offers an opportunity for actively managed commodities ETFs like the USCF SummerHaven Dynamic Commodity Strategy No K-1 Fund (SDCI), which can participate when they see bull markets forming. Such funds have fewer investing constraints than their index-linked ETF peers.
"Any two stocks inside the S&P 500 often move in tandem. But that’s not true in commodities. Cocoa, cotton, crude oil and copper all have different drivers," said Love. That means a supply crunch in the oil market could drive some commodity prices sharply higher while having a negligible effect on others.
During the past three years, the SummerHaven fund has jumped 62% while the iShares fund has climbed only 48% and the Invesco fund has risen only 37%. The SummerHaven fund also has a five-star Morningstar rating. It uses a fairly straightforward strategy, selecting from 14 commodities futures contracts, which are equally weighted and then rebalanced monthly. It charges 0.84% annually.
Another option for advisors seeking a dynamic approach is the Direxion Auspice Broad Commodity Strategy ETF (COM). Although the fund is linked to an index, it’s got a price momentum approach and is rebalanced monthly, which gives it the feel of active management.
For example, the Direxion fund will be long on an individual commodity showing an upward price trend. On the other hand, it will switch to cash when a commodity is in a downtrend. And the underlying index has the complete flexibility to be long on 12 commodities or on zero depending on what the price is doing. The fund has a four-star Morningstar rating and charges 0.70% annually.
Ultimately, adding commodities to an ETF portfolio is more than just choosing the fund with the lowest expense ratio. Advisors must decide if they want a static indexing approach with certain limitations or if they want a dynamic approach with more flexibility. Ultimately, that decision that can make a big difference.
Ron DeLegge II is the founder of ETFguide.com and author of several books, including Habits of the Investing Greats and Portfolio Architecture: A Handbook for Investors.