Commodity ETFs: A Couple of Broad Picks for Your Portfolio - dummies

Commodity ETFs: A Couple of Broad Picks for Your Portfolio

By Russell Wild

If you want direct commodity exposure in your investment portfolio, consider that a number of the newest ETFs and ETNs are promising to deal with some of the problems of the first-generation commodity funds.

The leader in this brigade is iPath, which in April 2011 introduced a new lineup of ETNs called Pure Beta indexes. You wouldn’t quite call these funds actively managed, but they aren’t quite passively run, either.

The Pure Beta ETNs promise to “mitigate the effects of certain distortions in the commodity markets” (this language refers to contango) by rolling over futures contracts in an allegedly more intelligent manner (less mechanically) than the older commodity funds that used futures.

It’s too soon to say whether Barclays’ strategy will prove successful, but keep an eye on the iPath Pure Beta Broad Commodity ETN (BCM), which uses this newfangled strategy to track a basket of commodities consisting of energy (37 percent), agricultural products (24 percent), precious metals (20 percent), industrial metals (16 percent), and livestock (2.5 percent).

The management fee is 0.75 percent. Ignore the rest of the Barclays’ Beta lineup that allows you to speculate on individual commodities, such as lead, nickel, and aluminum. (The ticker for that last fund is FOIL — cute, eh?)

Another ETN worth considering for commodity exposure is the ELEMENTS S&P CTI ETN (LSC). This fund tracks the S&P Commodity Trends Indicator–Total Return index. The fund tracks 16 different commodities, using futures contracts. Unlike Barclays’ funds, LSC uses a momentum strategy, buying “long” those commodities rising in price and selling “short” those commodities falling in price.

Backtesting of the index showed that this strategy, known as a managed futures strategy, has been successful for investing in commodities. (Of course, backtested strategies are notorious for performing less well in real time than their hypothetical numbers suggest.)

The fund was born in October 2008, and although that the strategy shows promise, it is far from proven. And just like any other kind of futures investing, but even more so, a managed futures strategy will not necessarily reflect ups and downs in the spot prices of commodities.

Because LSC is an ETN and not an ETF, remember that you get your money back only if the issuer remains solvent. This fund is issued and backed by HSBC Bank USA, which has the very same high credit ratings as Barclays.