The ongoing growth of the Australian ETF industry means that investors who have an interest in obtaining exposure to commodities are now able to choose between Commodity ETFs or Commodity Company ETFs. In this post I describe some of the key differences between these two types of products and why an investor may decide to choose one over the other.
Investing in commodity ETFs can provide investors a simple and cost-effective way to seek to profit from rising commodity prices. With these products investors are able to access the performance of commodities as simply as buying a share. Where possible, the underlying holdings of the commodity ETF will be the physical commodities themselves – for example our Gold Bullion ETF provides gold exposure backed by actual gold bullion held in a bank vault. However, as previously discussed here, where it is impractical to physically hold the commodities, commodity ETFs aim to track the prices of futures contracts over the commodities, rather than their “spot” prices. The correlation of these futures contracts with the actual commodities themselves will tend to be very high, but investors still need to be aware of the impact of the futures curve which can either positively or negatively impact performance depending on the ‘shape’ of this curve. I wrote about this in the context of our crude oil ETF here.
As the industry has continued to evolve and grow, there is now another way to obtain access to commodities – via a commodity company ETF. These products offer a number of benefits but also have their own set of risks. Which type you should be investing in for exposure to the commodities asset class depends on the reason you are investing. Let’s explore further.
First, let’s take a look at the different commodity and commodity companies ETFs you can invest in as an alternative. BetaShares currently offers the following commodity ETFs:
We also now offer the following commodity company ETFs:
You could ask yourself the following questions to help determine if you should be investing in the commodity ETF or commodity companies ETF:
1. What is your investment time horizon?
If you think the price of a commodity is going to move sharply up in the short term (within 3-6 months), you may be better off investing in a commodity ETF instead of the commodity companies. The price of a commodity ETF is directly affected by the underlying commodity itself and does not usually have a high correlation to major stock indices. On the other hand, if you have a longer time frame, you may want to look at the commodity companies ETF, as the investment will not be susceptible to any of the potential costs associated with investing in futures (unlike commodity ETFs).
2. Are you looking to diversify your portfolio at an asset class level?
Commodity companies ETFs have tended to have a relatively higher correlation to equity markets when compared to commodity ETFs, which typically have had a low or negative correlation to major asset classes. As such, an investment in commodity ETFs can provide an opportunity to offset risks associated with stocks, bonds and cash. Investors typically look at investing anywhere from 5-10% in commodities with the aim of diversifying portfolios and reducing volatility.
In terms of commodity company ETFs, keep in mind that the companies do not exhibit perfect correlation to the underlying natural resource and will be impacted by broad equity markets and sector-specific risks. If you think equity markets are going to go up, commodity companies may be the better way to go, but in the event of an equity markets fall, exposure to the commodity itself may be the better play.
3. Are you looking for dividends?
Commodities themselves do not pay any dividends so the only way you’ll make a profit investing in commodity ETFs is if the price of the underlying commodity itself goes up in value (note that although commodity ETFs may sometimes pay a distribution, the distribution will be attributable to the trading within the fund, or any hedging that may take place, not from the commodity itself). Investing in commodity companies ETFs, on the other hand, can generate dividends, which some investors target specifically.
As you can see, exposure to commodities can be obtained more directly through commodity ETFs or less directly through commodity companies ETFs. Which type to use needs to be determined based on your particular objectives and circumstances. You may even find that it makes sense to invest in both types of commodity exposures at the same time to satisfy all your objectives. Although there are many more questions to ask, I hope these three questions give you food for thought.