Exchange traded funds can gain exposure to the changing commodities market through futures-backed fund options or indirectly through company stocks of the producers of raw materials, but which is the better choice?
“Commodity prices have outperformed their respective producers, while experiencing a lower price volatility,” Maxwell Gold, Director of Investment Strategy at ETF Securities, said in a note. “Commodities historically are less sensitive to equity factors and may serve as a better source of diversification compared to commodity producers.”
Commodities are a great alternative investment that provide diversification benefits beyond traditional stock and bond portfolio allocations. With the advent of the ETFs, investors are now able to quickly and easily access broad commodities futures or the company stocks of producers. While more recent performances have been lackluster, commodities have offered a positive risk-adjusted return over the past two decades, both in the price of commodity futures and equities of global producers.
Investors may notice that over the past two decades, an equity investment in commodity companies outperformed the underlying commodities on a total return basis by about 400 basis points. However, this outperformance has come with a 42% higher volatility compared to the underlying commodities, along with greater equity correlation.
Investors should also note that broad commodities have significantly outperformed producers on a spot price basis, with underperformance on manifesting when commodity futures rolling into a higher-priced contract at maturity, or otherwise known as contango.
Consequently, investors may consider later-dated futures contract exposure to diminish the negative effects of contango on their investments.
“Selecting commodity contracts further into the future may help provide a positive yield for investors,” Gold said. “Historically, the roll yield for longer-dated commodity indices garnered a higher total return than commodity producers (6.38% vs 6.23%) as well as a lower volatility than producers and standard commodity indices.”