RIAs say they don’t want more commodities funds, but do they understand what’s on the market?
More than three-quarters of registered investment advisors don’t want to see any more commodities ETFs come onto the market, citing oversaturation, product complexity and risk as the top three reasons for their views, according to a study conducted by Rivermark Research, a Dallas-based consultancy.
“An overwhelming percentage of advisors do not believe that new commodity ETF and ETN products, such as gold, oil and other energy and precious metal ETFs, will fill any portfolio holes that are not already available in current products,” Robert Crain, vice president of Analytics and Research at Rivermark, said in a press release highlighting the findings of the study.
The firm said the fact that 80.6 percent of RIAs think new commodities ETFs aren’t necessary suggests ETF sponsors may “adopt a more scientific, demand-focused approach to product development.” Still, there’s evidence investors would be well served if they better understood the challenges associated with investing in commodities ETFs, especially those that use futures to achieve their strategies.
Indeed, if one accepts the basic conclusions of academics, such as Geert Rouwenhorst of Yale, that commodities are a bona fide asset class providing access to more noncorrelated assets that help investors design broadly diversified investment portfolios, then it would behoove advisors to separate the wheat from the chaff when it comes to the world of commodities.
Confronting Contango
In other words, it’s a fairly straightforward affair to invest in an equities-based fund that happens to invest in commodities-related companies, such as the Market Vectors Agribusiness ETF (NYSEArca: MOO). The firms in MOO’s portfolio have benefited from the booming demand from emerging market countries, fueling the ETF’s nearly 30 percent rise since its launch in the summer of 2007.
But the pursuit for diversification can become downright dangerous when it comes to futures-based commodities investing. That’s because futures markets are subject to variations in pricing over time that can work against returns.
Specifically, a condition called contango—wherein prices of successive futures contracts ratchet up each month over time—can seriously erode investment returns as managers “roll” investment exposure into the next, pricier, contract along a futures curve that’s in contango.
Early-generation broad ETFs that hold many different types of futures contracts—from oil, to soybeans, to industrial metals—have performed quite poorly at a time when prices of all kinds of commodities have gone through the roof.
Take the iShares S&P GSCI Commodity Indexed Trust (NYSEArca: GSG). The fund, which has been around since the summer of 2006, has lost almost 30 percent in the past five years because of contango—again, at a time when the entire world of commodities is in the middle of its biggest boom in 40 years.
The good news is that other futures-based ETFs designed to minimize the deleterious effects of contango have done considerably better. The PowerShares DB Commodity Index Tracking Fund (NYSEArca: DBC), which was launched in February 2006, has returned around 20 percent in the past five years through a rules-based "optimum yield" rolling system that invests in different contracts all along the futures curve, and not just in front-month contracts.
