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Let’s start from the basics – what exactly is an ETF? Exchange-traded funds, ETFs for short, are a collection of financial assets (from company equity or debt to tangible goods) that are bought and sold on financial exchange markets. In order to invest in ETFs, it’s important to first understand what they are and how they work.
How Do ETFs Work?
This kind of pooled investment functions similarly to mutual funds, grouping together financial assets of a particular index, industry or commodity, but maybe traded on a stock exchange according to prices that fluctuate according to the supply and demand of the assets, just like individual stocks. However, the structure of ETFs may also track a variety of different assets, according to specific investment strategies.
What Is a Commodity ETF?
Commodity ETFs are a type of exchange-traded fund that may track the value of debt or equity of companies that produce a specific type of commodity, the value of contracts for future buying and selling of certain commodities, or even the value of physical commodities themselves. Some Commodity ETFs track the value of a commodity index, grouping multiple different kinds of individual commodities.
Are there any commodity ETFs?
There are a number of different kinds of commodity ETFs traded on stock exchanges like the LSE and NYSE, tracking the performance of precious metals, oil & gas, agricultural products, and there are even clean energy ETFs.
Understanding Commodity ETFs
Commodity ETFs are a good way for investors to include commodities in their investment portfolios, which would otherwise be difficult or inconvenient to access. Investors that purchase shares of a commodity ETF are not the owners of the physical commodities themselves, or even the shares of capital or bonds of the companies. Rather, they pay into a pool of assets that are owned and managed by the fund managers, who pay out a return based on the performance of the tracked assets.
Commodity ETF vs. Commodity Exchange Traded Note (ETN)
Commodity ETF portfolios can include a range of different types of financial assets, from company equity to derivatives like the value of future sales contracts of the commodities and bank issued debt (similar to bond ETFs): the latter is referred to as an Exchange Traded Note (ETN).
Exchange-traded notes are a type of debt instrument issued by a bank with a maturity date and which is backed by the issuing bank. ETNs typically match returns of the underlying asset by buying stocks and bonds, and results in less risk of tracking error in the value of the portfolio. However, with this kind of asset, there is the risk that the issuing institution, especially those with lower credit, is not able to cover the debt.
How commodities performed in 2021 across world currencies
During 2021, the financial markets, especially commodities, witnessed continued uncertainty and volatility, stemming from disruptions in global supply chains, rising inflation, and the pandemic’s ebb and flow of infection rates and corresponding restrictions. In fact, commodities proved to be one of the most volatile asset classes last year. However, in the post pandemic economy in which the countries begin to reign in restrictions, commodities have outperformed other assets, due to surges in demand.
Disadvantages of Commodity ETFs
Just as with any other type of investment, there are both advantages and disadvantages to investing in Commodity ETFs. Equity-based commodity ETFs can be a convenient way to include commodities into an investment portfolio, since they tend to have lower management fees associated with them and do not present the same risks as ETFs based on physical assets or derivatives. However, investing in equity adds an additional layer to the investment, placing the company between the investor and the commodity.
Commodity ETFs based on the value of stockpiled physical assets, providing more direct exposure to investors, are more limited in terms of commodity type – most physical-backed ETFs are limited to precious metals like gold or silver. Another disadvantage are the high costs involved in stockpiling and securing the resource, which can be significant.
As for futures-based commodity ETFs, because they are based on future contracts and not the underlying physical commodities, they do not incur high management costs. However, futures-based commodity ETFs are subject to the risk that the prices of a commodity are higher in the present than they will be in the future (backwardation). When the market expects prices to be higher in the future than in the present (contango), commodity ETF managers will sell expiring lower-priced futures and buying higher-priced futures, reducing returns and giving way to tracking error.
How Do You Buy Commodity ETFs?
You can usually buy commodity ETFs with a general investment account, though investing in commodity ETFs is generally considered riskier than other types of investment, though it is interesting to investors who are looking to diversify their investment portfolio, especially considering the negative correlation commodities has to stock investing.
Investment in a Commodity ETF Index, usually made up of futures related to a broad basket of commodities is the most common strategy among investors, though it is also possible to invest in subindices composed of a selection of commodities or even a single commodity.
Examples of a Commodity ETF
There are a variety of different kinds of commodity ETFs. Some commodity ETFs track the performance of precious metals, like silver or gold, while others track the value of oil & gas, or even agricultural products like grains. Other types of commodity ETFs diversify the basket of commodities that they track. However, since some of these commodities cannot physically be stockpiled like precious metals, the ETFs are based on the future sale of contracts of the commodity.
What Are the Best Commodity ETFs?
According to ETF tracker justETF.com, the best performing commodity ETFs are those that track a diversified portfolio of commodities, mitigating risk and outperforming the market. Based on the one year returns provided, posted as of August 2022, the top performing ETFs were:
- Lyxor Commodities Refinitiv/CoreCommodity CRB TR UCITS ETF (+57.36%)
- L&G Longer Dated All Commodities UCITS ETF (+55.15%)
- Market Access Rogers International Commodity UCITS ETF (+54.33%)
What is a good ETF for commodities?
In terms of returns for the investor, some of the best performing Commodity ETFs have been those with greater diversity in the fund portfolio, since they are better able to reduce market risk and provide a positive return. However, the best commodity ETF for you will depend on your investment approach and risk tolerance.
What Is a Good Commodity ETF for a Buy-and-Hold Investor?
For buy and hold investors, commission and management fees associated with commodity ETFs can be quite high, discouraging investment in commodities. Good Commodity ETFs will thus be those that match the investors’ risk appetite and investment strategy, while maintaining low expense ratios.
Does Vanguard have a commodity ETF?
Vanguard’s Commodity ETF, Vanguard Commodity Strategy Fund (VCMDX), is a diversified portfolio that includes a range of commodities, from agricultural products, livestock, precious and industrial metals, and energy products in order to hedge against both market risk and inflation. According to Vanguard, as of June 2022, its Commodity ETF provides an annual yield return of 33%.
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