The Problem With Your Commodity Index ETF

Many diversified portfolios may have exposure to commodities in order to gain on global growth trends, especially as emerging economies develop.

This exposure to commodity-related investments is practical not only for portfolio diversification but also inflation protection. But outside of shorter holding periods for hedging purposes, commodities indexes can often drag down portfolio performance over the long term while also being inherently cyclical.

Commodity ETF return data shows that even broad-based commodity indexes are exposed to asymmetric risks that vary in underlying exposure depending on methodology.  These commodity indexes also have negative long-term returns.

Additionally, there are a few economic reasons that commodity indexes and the broad baskets they follow decline in price over time.

  • Influence of technology is often deflationary
    • Higher production raises supply and lowers commodity prices
  • Commodity buyers aren’t the same as stock investors
    • Producers and buyers of commodities affect price (e.g. farmers)
    • Production is sometimes maximized, pushing commodity prices lower
  • Commodities are inherently cyclical
    • When prices are high, producers increase output
    • Eventually, higher supply lowers commodity prices
  • Storage costs
    • Investors may pay these pass-through costs in futures contracts

For more information on gaining exposure to commodity-related investments with less cyclicality, consider equity exposure in the real asset category.

Past performance is not indicative of future results.

Important Risks: Equity securities, such as common stocks, are subject to market, economic and business risks that may cause their prices to fluctuate. Investments made in small capitalization companies may be more volatile and less liquid due to limited resources or product lines and more sensitive to economic factors. The Funds may invest in foreign securities which involves certain risks such as currency volatility, political and social instability and reduced market liquidity. Emerging markets may be more volatile and less liquid than more developed markets and therefore may involve greater risks. The Funds may invest in ETFs (Exchange-Traded Funds) and is therefore subject to the same risks as the underlying securities in which the ETF invests as well as entails higher expenses than if invested into the underlying ETF directly.

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