Ever since the stamp duty restrictions were lifted, new ETF launches have become a common occurrence. Now, however, we are starting to see more exotic exchange traded vehicles hitting the market. The most prominent of these are the Exchange Traded Commodities, or ETCs, offered by Exchange Traded Securities.
On 27 November, ETF Securities launched four new ETCs to join their existing range:
ETFS Forward Natural Gas
ETFS Forward Heating Oil
ETFS Forward Lean Hogs
ETFS Forward Live Cattle
This brings the total number of ETCs trading on the London Stock Exchange to 56. The funds range from more diversified vehicles to some that are fairly obscure like those listed above. Whilst some ETC
s buy physical commodities, many, such as those above, are essentially debt agreements that link the value of the note to various commodity indexes. In both cases, they give investors a way to participate directly in commodity price moves at relatively low cost.
Sensible Commodity Investing
It would be easy to get caught up in the hype that currently surrounds many of the world’s major commodities. Given the fat returns they’ve generated lately, you may be tempted to pile into ETFs that track gold, oil, or even wheat prices, but as our recent Dangers of Performance Chasing article highlights, this is unlikely to be a wise move. Hot performing funds can cool off quickly, particularly in the risky commodity asset class, where performance is at the mercy of a variety of factors such as weather, supply shocks and political events which are almost impossible to predict. For example, ETFS Natural Gas has lost 14.76% over the last month, a sizable fall that many investors would find hard to stomach.
Consequently, we aren’t fans of single commodity funds since they are often too volatile to use well. However, there is a case to be made for including a more diversified commodity vehicle in your portfolio because it can actually reduce the overall risk and provide much needed diversification in difficult market environments.
Over the long term, commodity indices have shown little correlation with the broad stock market, and for long stretches the correlation has been negative. As such they have the potential to perform well when the rest of your portfolio is struggling. Therefore the best reason to include them in your portfolio is for long-term diversification. In this regard, we prefer broadly diversified commodity ETFs, such as ETFS All Commodities DJ-AIGCI to the narrower examples listed above. This particular fund's benchmark index won’t let a single commodity class consume more than a third of the portfolio. Therefore, it is far less energy-heavy than other commodity benchmarks. That’s helped it sidestep some of the volatility that comes with commodity investing. The fund currently invests 33% in energy, 30% in agriculture, 19% in industrial materials and 9% in both precious metals and livestock, adding diversification to a portfolio and removing the temptation for investors to try and time the market themselves.
