Choosing The Right Commodity ETF

March 17, 2016

Commodities have been performing a bit better in recent weeks. From gold to oil and even iron ore, prices for many major commodities jumped significantly from their cheapest levels of 2016, raising the possibility that the worst may be behind for the asset class.

That being said, performance in commodities has been far from even this year. For example, while gold is up 16% year-to-date, natural gas is down 21%, and oil is close to flat.

Thus, even while commodities as a whole may have turned the corner, the rebound would do you no good if you bought the wrong one. Instead, as the research suggests, investors are better off buying a broad basket of commodities as a component to a well-diversified portfolio.

ETF Selection Key

Most exchange-traded funds that track broad commodity indexes are up this year, but not all of them. The iPath Pure Beta Broad Commodity ETN (BCM | C-24), for example, gained 2.8% this year, while the iPath S&P GSCI Total Return ETN (GSP | D) fell by 3%.

Perhaps more than any other asset class, the differences between the various broad-commodity ETFs are stark. BCM, for example, tracks the Barclays Commodity Index―which weights its holdings based on liquidity and caps the weight of commodity sectors at 35%. It also picks and chooses which futures contracts to hold in an effort to mitigate the effects of contango.

Meanwhile, GSP and the iShares S&P GSCI Commodity ETF (GSG | D-91) track the S&P GSCI, which is production-weighted and doesn't cap any sectors. That leaves energy with a massive 70% weight in those ETFs.

GSP and GSG don't use any contango-mitigation techniques, which helps explain their underperformance this year.

For exposure to the S&P GSCI with contango mitigation, the iPath Pure Beta GSCI-Weighted ETN (SBV | D-62) and the GS Connects S&P GSCI Enhanced Commodity Total Return Strategy ETN (GSC | F-88) fit the bill.

Bloomberg Commodity Index

In the middle of the pack are a host of other commodity ETFs that track other big-name commodity indexes, all with their own unique twists. One of the most popular of these is from Bloomberg.

The iShares Commodity Optimized ETF (CMDT | D), the iPath Bloomberg Commodity Index Total Return ETN (DJP | C-18), and the Etracs Bloomberg Commodity Index Total Return ETN (DJCI | C-48) follow the Bloomberg Commodity Index (formerly the Dow Jones-UBS Commodity Index).

The Bloomberg index weights its holdings two-thirds by trading volume and one-third by world production, while capping the weights of the various commodities it holds.

DJP uses a simple front-month strategy to get its exposure to the index, while CMDT tries to optimize its contracts to mitigate contango and maximize backwardation.

The Bloomberg ETFs are all up less than 1% so far this year.

Equal-Weighting Schemes

Meanwhile, the WisdomTree Continuous Commodity ETF (GCC | C-5) tracks the Thomson Reuters Equal Weight Continuous Commodity Index. GCC equal-weights 17 commodities and uses futures contracts averaged across the nearest six months of the futures curve to maintain its exposure.

Another ETF with an equal-weighting scheme is the United States Commodity ETF (USCI | D-11). Unlike GCC, USCI's basket of commodities isn't static. Each month, it picks the seven commodities with the greatest backwardation (or least contango) and the seven commodities with the greatest 12-month price momentum and equal weights them.

Another product with a similar strategy but with little in the way of assets is the Credit Suisse X-Links Commodity Rotations ETN (CSCR | F-16), which equal-weights eight commodities with the most backwardation.

Active Management

For those who believe commodity picking is a viable strategy, two actively managed ETFs are available in the space. The First Trust Global Tactical Commodity Strategy Fund (FTGC | C) is one such active fund. Currently, FTGC is heavy on agriculture.

Another option in the active space is the PowerShares DB Optimum Yield Diversified Commodity Strategy (PDBC | F). Using active management, PDBC aims to outperform its sister fund, the PowerShares DB Commodity Tracking ETF (DBC | D-26).

DBC is the most popular ETF in the broad commodity segment, with $1.9 billion in assets, and tracks the DBIQ Optimum Yield Diversified Commodity Index. DBC holds a capped, production-weighted basket of 14 commodities, while employing contango-mitigation techniques.

Broadest Exposure

Finally, there are two funds that provide broader exposure to the asset class. The Elements Rogers International Commodity Total Return ETN (RJI | C-28) holds commodities as diverse as orange juice, milk, and rapeseed. The constituents of the underlying index are chosen by a committee of "wise people" and is based on world consumption patterns and liquidity.

Meanwhile, the Etracs CMCI Total Return ETN (UCI | C) tracks an index of 28 commodities weighted based on "economic importance."

RJI uses front-month futures for its exposure, while UCI uses five different futures contracts per commodity in an effort to reduce contango.

Ticker Name Return (%)
BCM iPath Pure Beta Broad Commodity ETN 2.78
CMDT iShares Commodity Optimized 0.97
GCC WisdomTree Continuous Commodity 0.90
USCI United States Commodity 0.90
UCI Etracs CMCI Total Return ETN 0.56
CSCR Credit Suisse X-Links Commodity Rotation ETN 0.47
DJCI Etracs DJ-Bloomberg Commodity Total Return 0.35
DJP iPath Bloomberg Commodity Index Total Return ETN 0.29
FTGC First Trust Global Tactical Commodity Strategy 0.15
RJI Elements Rogers International Commodity - Total Return ETN -0.67
GSC GS Connect S&P GSCI Enhanced Commodity Total Return Strategy ETN -0.93
PDBC PowerShares DB Optimum Yield Diversified Commodity Strategy -1.12
DBC PowerShares DB Commodity Tracking -1.19
SBV iPath Pure Beta S&P GSCI-Weighted ETN -1.51
GSG iShares S&P GSCI Commodity -2.67
GSP iPath S&P GSCI Total Return ETN -3.02

Note: Returns based on year-to-date change in NAVs.

Contact Sumit Roy at [email protected].

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