How Balanced Is Your Commodity ETF?

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As natural resource prices have climbed skyward, interest in exchange-traded products that offer exposure to commodities has accelerated as well. While some investors prefer to achieve targeted access through resource-specific funds–such as those focusing on corn (CORN), sugar (SGG), or copper (JJC)–the most popular commodity ETPs are those that include a variety of types of resources. And while these products are similar in that they employ a broad-based technique to delivering commodity exposure, they are far from identical.

The commodity asset class can generally be divided up into five separate sub-sectors: energy, agriculture, industrial metals, precious metals, and livestock. Each of these groupings offers unique risk/return profiles; precious metals may have appeal as safe havens, while industrial metals tend to move in unison with global demand for raw materials. Meanwhile, Energy and agricultural commodities are subject to big swings related to supply disruptions. Just as slices of the global equity market often exhibit drastically different results, the various commodity sub-classes are far from identical in terms of volatility and price drivers.

Under The Hood Of Commodity ETPs

There are multiple ETPs offering exposure to these corners of the commodity market that may appeal to investors with strong feelings about a specific type of natural resource. Those seeking to establish a longer-term allocation to natural resources, however, may wish to cast a wider net that includes each of the “five families.”

If you’re considering one of these such funds, it is well worth your while to consider just how balanced the underlying holdings are. Many broad-based commodity ETPs are linked to indexes that include agriculture, livestock, and metals, but are tilted heavily towards energy resources. One such example is the iPath S&P GSCI Total Return Index ETN (GSP); this note moves in unison with an index that is currently comprised of nearly 70% energy futures contracts, including WTI, Brent oil, heating oil, and natural gas. Precious metals make up only about 3% of GSP, while livestock accounts for less than 5% of underlying assets [What Every Investor Should Know About Commodity Investing].

The sector profile of another iPath commodity ETN is entirely different; the Dow Jones-UBS Commodity Index ETN (DJP) spreads its commodity exposure more evenly across the five broad types of commodities. Though energy still makes up the most significant weighting, the allocation is about half of GSP, with each other commodity type receiving a bigger weighting:

Commodity GSP DJP
Energy 69.0% 34.3%
Agriculture 16.0% 29.3%
Industrial Metals 7.6% 16.5%
Precious Metals 3.0% 14.0%
Livestock 4.4% 5.9%
As of 3/31/11

GSP isn’t the only commodity ETP with a heavy bias towards energy, and DJP certainly isn’t the most diversified option available. The iShares GSCI Commodity-Indexed Trust (GSG), which has more than $2 billion in assets, seeks to replicate the same index (the S&P GSCI Total Return Index) to which GSP is linked, and as such, features the same tilts towards energy commodities and away from precious metals and livestock.

GCC: One Of A Kind Commodity ETP

For some investors, a heavy tilt towards energy may be desirable. Given the potential for rapid price appreciation and the relative level of global production, it’s easy to make a case that energy should account for the bulk of total commodity exposure. But it may also be desirable to strike more of a balance between natural resources, smoothing overall volatility by including more components. For those interested in commodity exposure but not convinced that a bias towards oil and gas is the optimal strategy, the GreenHaven Continuous Commodity Fund (GCC) is one option that might be worth a closer look. GCC is linked to an equal-weighted index of 17 commodities, plus an additional Treasury Bill yield. As a result, the fund has a much lower concentration of energy exposure; natural gas, crude oil, and heating oil combine to make up only about 18% of the total portfolio [see Five Ultra-Concentrated ETFs].

GCC isn’t without its biases; copper is the only industrial metal included in the underlying index, and there is a noticeable tilt towards agricultural commodities. The softs–cotton, coffee, sugar, cocoa, and orange juice–account for almost 30%, while livestock and grains make up 12% and 18%, respectively. The result is a commodity ETF shifted towards agriculture:

Commodity GSP DJP GCC
Energy 69.0% 34.3% 17.6%
Agriculture 16.0% 29.3% 41.2%
Industrial Metals 7.6% 16.5% 5.9%
Precious Metals 3.0% 14.0% 17.6%
Livestock 4.4% 5.9% 11.8%
As of 3/31/11

Impressive Results

Since debuting in early 2008, GCC has been on a wild ride. Predictably, this fund lagged behind other commodity products as oil prices spiked, but made up ground when energy commodities experienced weakness and through much of the agricultural rally of the last year. GCC has beaten both DJP and GSP by a wide margin over the last three-plus years, highlighting the merits of the equal-weighted strategy employed [see the GCC fact sheet]:

There’s no universally right answer for commodity exposure. For certain investors in certain environments, a profile heavy on energy may be ideal. In others, a more balanced approach may be capable of better performances and lower volatility. But as the chart above demonstrates very clearly, the allocation methodology across various commodity types can have a major impact on the returns generated. Not all broad-based commodity ETPs are created equal; be sure to take a look under the hood before establishing a position [Beyond DBC: Three Promising Commodity ETF Options].

Disclosure: No positions at time of writing.

This entry was posted in Asset Allocation, Commodity ETFs and tagged , , . Bookmark the permalink.

Commodity HQ is not an investment advisor, and any content published by Commodity HQ does not constitute individual investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities or investment assets. Read the full disclaimer here.

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