Equity-Based Commodities: Better Than Futures?

October 29, 2009

Looking for spot commodity returns? Stock-based ETFs may actually be a better choice than commodity futures.

 

Equities-based commodities products are emerging from the dark corner of the commodities ETF space.

New offerings are flaring up with the promise of solving?or at least dodging?the issues that plague their derivatives-based cousins. Among them, growing concerns about a heavier CFTC hand on the futures markets have many investors looking for alternative ways to obtain commodities exposure.

Of course, equity-based products aren’t a one-for-one replacement for futures or spot price exposure. Equities are necessarily impacted by trends in the broader stock market. The long-term correlation between equities and futures is good, but not perfect.

Investing in commodities-linked equities can be more volatile than tracking spot prices of commodities, warns Ed Lopez, product manager for Van Eck’s family of commodity equity ETFs.

“Any small movement in spot prices can actually affect producers greatly,” Lopez said.

But then again, futures-based funds are not a panacea either. As Adam De Chiara, co-president of Jefferies Asset Management, explained, futures-based commodity index products may, over time, demonstrate significant tracking error against spot indexes due to the influence of contango.

The futures-based S&P GSCI Commodity Index, for instance, delivered a spot return through September of 33 percent. But once you account for contango, the spot return is just 4.7 percent.

By contrast, the Rogers-Van Eck Hard Assets Producers Index (RVEI), an index of commodity equities, has gained 35 percent in that period, actually coming closer to the spot commodity return.

Commodity Stocks Or Commodity Futures: Which Is Better?

 

10_29_09_Feature-Fig1

 

“Equities are performing better than futures this year,” Lopez said. “And equities can give investors a pretty decent long-term growth potential” as opposed to futures, he added.

If investors want to tap into commodity-producing equities, they have a variety of choices. Let’s break them down a bit.

CRBA Vs. MOO

One of the newest offerings out is ALPS ETF Trust’s Jefferies TR/J CRB Global Agriculture Equity Index Fund (NYSEArca: CRBA). The fund invests in companies that are directly linked with seed production, seed traits, chemicals and fertilizers, farm machinery, equipment and irrigation, agricultural products, livestock and aquaculture.

CRBA enters a space well filled by the two-year-veteran Market Vectors - Agribusiness ETF (NYSEArca: MOO), a $1.6 billion ETF that also invests in agricultural names. MOO also happens to be marginally cheaper than CRBA: MOO’s expense ratio is 0.59 percent vs. CRBA’s 0.65 percent.

Perhaps the biggest difference between the two funds is at the broad sector level: MOO has 41 percent of its portfolio allocated to consumer staples, while CRBA has only 29 percent tied to that sector. By contrast, CRBA is 61 percent exposed to materials, while MOO is only 46 percent.

That means that while MOO emphasizes producers whose profits are determined primarily by distribution, marketing and packaging, CRBA focuses more heavily on manufacturers of seeds, chemicals and fertilizers, Richard Phillips, of S-Network?the company that created CRBA’s underlying index?said.

“This sector [materials] provides the broadest measure of agricultural productivity,” Phillips said.

But Lopez argued that MOO’s nearly 10 percent allocation to packaged foods and meats?namely companies like
Tyson, Del Monte and the like?gives the fund a more diversified exposure to commodities. CRBA has no exposure to stocks in that segment, Lopez said.

“Structurally, the funds are very similar. But MOO is more diversified,” said Lopez.

All in all, MOO holds 47 companies in its portfolio, compared with 29 in CRBA. And MOO provides exposure to 15 countries, more than CRBA’s 12.

Both have nearly a 50 percent allocation to
U.S. stocks, and 50 percent overseas.

Lopez said that while CRBA isn’t a dramatically different new product from MOO, its launch testifies to the growing demand for such equities-linked vehicles.

 

 

HAP Vs. CRBQ

Market Vectors RVE Hard Assets Producers ETF (NYSEArca: HAP), which is one of the few equities-based commodities fund to provide global exposure to commodities through investments in producers and distributors, has seen assets cross the $100-million mark this month amid returns of some 33 percent year-to-date.

Once the sole global exposure provider, the fund now faces competition from another newcomer: the recently launched Thomson Reuters/Jefferies CRB Global Commodity Equity Index Fund (NYSEArca: CRBQ).

Like HAP, CRBQ also provides global exposure to commodities producers through a portfolio comprising 147 stocks. HAP has nearly 300 stocks.

Both funds are similar in construction, holding only stocks of companies that derive at least 50 percent of gross revenues from the production of commodities.

They provide similar global exposure, with a heavy focus on U.S. and Canada, and relatively similar sector weights.

 

Sector Allocations As Of September:

 

 

HAP

CRBQ

Energy

41%

39%

Agriculture

30%

38%

Base/Industrial Metals

13%

14%

Precious Metals

7%

9%

Alternatives

4%

N/A

Paper & Forest Products

4%

N/A

 

 

 

Top-10 Country Breakdown As Of September:

 

HAP

CRBQ

U.S.

39%

37%

Canada

13%

14%

Great Britain

7%

8%

Russia

6%

6%

Switzerland

4%

5%

Australia

4%

2%

France

3%

2%

Brazil

3%

3%

Japan

2%

N/A

South Africa

2%

2%

Netherlands

N/A

2%

 

One difference is that HAP provides an allocation to renewable resources that CRBQ doesn’t.

“That’s a very forward-looking component of the index,” Lopez said.

According to Lopez, the “global growth story” will be led by emerging markets, and the region has a lot of infrastructure work to do in the renewable resources arena.

Others might argue that renewable resources detract from the broader focus of the portfolios, which is to invest in the commodities that people use every day. The flip side of HAP’s allocation to renewable resources is a much lower weight in agricultural firms compared with CRBQ.

This week, the two now have a third competitor to face, which brings to the table a new twist: GRES.

IndexIQ’s newest launch, the IQ ARB Global Resources ETF (NYSEArca: GRES) bills itself as the first global resources hedged ETF.

GRES differs from its competing funds in a number of ways. For starters, it has a much lower allocation to energy: just 9.6 percent compared with approximately 40 percent for HAP and CRBQ.

The bigger difference, however, is that GRES takes on short positions in the S&P 500 and MSCI EAFE indexes in an attempt to limit the influence of market returns on the portfolio. By doing so, it aims to tighten the correlation between the fund’s return and the return of the spot commodities market. The gambit should limit the volatility of the fund, and may boost correlations, but it will also limit the fund’s upside.

The Big Picture

Year-to-date, commodities exchange-traded products have attracted nearly 40 percent of the total net inflow of investment in the ETF space?more than $21 billion?second only to taxable-bond ETFs, according to Morningstar.

That’s a significant jump from 2008 levels, when the asset class represented less than 9 percent of the total investment pie.

“Commodities are in the middle of a secular bull rally,” Lopez said. “After a sharp correction in 2008, we now have values back to 2003 levels. We see this is a great buying opportunity moving forward.”

And while the biggest players in the commodities space are the futures-based commodities products, equities-based commodities vehicles are gaining a following.

Year-to-date, equities-based offerings have accounted for 5.84 percent of all net investment inflow, more than twice as much the levels seen last year, according to Morningstar.

“In certain macro environments, commodity-linked equities may outperform commodity futures as a proxy for actual exposure to the spot prices of commodities,” said De Chiara, while noting that in other markets, the reverse may be the case.

“Just as investors look to commodities to diversify their overall portfolios, it may make sense to diversify commodity exposure itself by utilizing a multi-tiered approach that includes both commodity equities and futures,” De Chiara added.

 

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