What You Need To Know About Commodity Indexes

For many investors, index investing continues to draw support in most portfolios. The proponents of the passive style of investing continue to grow as the poor returns of the “lost decade” have shown that active investment management, for the most part, fails to the beat the market–especially once trading costs, fund fees and taxes are taken into account. As index investing is relatively passive, index funds usually have lower management fees and expenses than actively-managed funds. As such, the number of stock and bond index funds and ETFs continues to grow, and that growth is also spreading into the commodity space [for more commodity news and analysis subscribe to our free newsletter].

As interest in natural resources has exploded over the last few years, Wall Street has been turning various commodity indexes into mutual funds and ETFs regular retail investors can bet on. Offering several advantages to purchasing individual futures contracts, these indexes allow portfolios to tap into the wide world of hard asset investing.

Pros and Cons

Choosing to go the index route for their commodity investments does have several benefits for investors. Like a stock index–which owns a basket of firms–a commodity index will track a broad range of futures contracts, which provides investors exposure to all things hard asset, from energy commodities like oil and natural gas to softs like cotton and coffee. This provides diversification benefits and downside protection if one or more commodity sectors experience issues. However, this same effect can negate total return if one commodity rallies ahead while the rest stay muted.

Secondly, broad commodity indexes provide positive correlations to inflation and the changes in the rate of inflation. Inflation measures are generally sweeping in their construction. As such, by buying an index, investors are able to tap the broad spectrum of these measures’ inputs. Commodities also offer an inherent or natural return that is not conditional on skill–it’s based purely on supply/demand. An index enhances this fact even further [see The Ten Commandments of Commodity Investing].

Finally, buying a fund that tracks a natural resource index is a lot cheaper than buying individual futures or opening a managed futures account with an authorized commodity trading advisor (CTAs). These accounts can have minimum investments north of $50,000. Commodity index mutual funds can be had for around $3,000, while broad natural resource ETFs can be purchased for the cost of one share or bought for $40 on average, not to mention lower management fees as well as lower redemption fees. That cost advantage could mean some serious savings for the retail set. Additionally, the lower initial investment requirements for buying an index fund allow more investors to tap the sector. With so many index choices, exactly where should investors place their bets?

Here’s a rundown of what indexes are available for investors and what makes them tick.

Goldman Sachs Commodity Index

Considered to be the first practical and investable commodity index, the Goldman Sachs Commodity Index was created in 1991 and is now called The S&P GSCI. The index is calculated primarily on a world production weighted basis and is comprised of the principal physical commodities that are the subject of active, liquid futures markets. This index currently comprises 24 commodities from all commodity sectors including energy, industrial metals, agricultural, livestock and precious metals. The fund’s weighting towards production means that it is high on energy industry stocks. Currently, that sector drives its performance with 69% on its holdings in various energy commodities. That could be a major drawback if energy prices slip.

The popular iShares S&P GSCI Commodity-Indexed Trust Fund (GSG) and the iPath S&P GSCI Total Return Index ETN (GSP) are two ways investors can tap the index.

Dow Jones-USB Commodity Index

Unlike the S&P GSCI, the Dow Jones-USB Commodity Index is designed to minimize concentration in any one commodity or sector. No one commodity can compose less than 2% or more than 15% of the index, and no sector can represent more than 33% of the index. This index currently has 22 commodity futures in seven sectors. The weightings for each commodity included in DJ-AIGCI is calculated based on the proportion of each individual commodity with regards to its global economic significance and market liquidity. Energy is still the top dog in the index, but it is capped at 33% as are agricultural commodities [see 7 Commodity Terms Traders Must Know].

With $1.8 billion in assets and swift trading volume, the extremely popular iPath DJ-UBS Commodity Index TR ETN (DJP) could be the best way to access the index. However, investors can also play it via the UBS E-TRACS DJ-UBS Commodity ETN (DJCI).

Rogers International Commodity Index

For commodity investors, Jim Rogers is seen as THE market guru. Therefore, for some investors, his created index can be viewed as the gold standard. Gold standard or not, it certainly is the most broad. The index tracks 37 futures contracts, quoted in five different currencies, and listed on 13 exchanges in six countries; this provides some serious diversification. While the obvious commodities are included–like Brent crude oil or corn–the RICI also includes exposure to natural resources like rubber, milk and palladium.

Each commodity is rebalanced at the start of each month towards initial weights. The RICI has had very few changes since 1996, making it the most stable, consistent and transparent of all the commodity indexes. Basically, when an investor buys the RICI, they know what they will own a few years down the road. That’s a sharp contrast to the other commodity indexes, which change significantly over the years.

With $650 million in assets, the ELEMENTS Rogers Intl Commodity ETN (RJI) offers investors a way to trade the extremely broad index.

Other Popular Indexes

While the previous three are the most popular choices, there are others for investors to consider. The SummerHaven Dynamic Commodity Index, which can be tracked via United States Commodity Index (USCI), tracks 14 futures that are selected on a monthly basis from a list of 27 possible contracts. The index is rules-based and rebalanced monthly based on the observable price signal, providing a quantitative spin on traditional index investing [see Is Commodity Investing Dying? Part 1 and Part 2].

Likewise, the Continuous Commodity Index–played via the GreenHaven Continuous Commodity Index (GCC)–tracks 17 equal weighted commodities plus an additional Treasury bill yield. The index offers significant exposure to grains, livestock and soft commodities, and a lower energy weighting than many of the other popular commodity indexes around.

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Disclosure: No positions at time of writing.