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The 5 Best Commodity ETFs for 2022

In times of stock market volatility, commodity investing can be an effective way to smooth out the ups and downs and maintain risk management in your portfolio. Commodities are goods used as inputs into the economy — including precious metals, natural gas, and agricultural products. As they are largely separate from the day-to-day volatility of the stock market, commodities can be an effective way for investors to diversify their portfolios and protect against inflation and rising interest rates.

But investing in a single commodity is rarely practical. Even buying physical gold means you need a secure place to store it during the holding period and will need to find a buyer (at a reasonable price) when it comes time to sell.

The best commodity ETFs eliminate much of the hassle of commodity investing, offering securitized access to the asset class via funds that can be priced and traded just like stocks.

What is a Commodity ETF?

An exchange-traded fund (ETF) is a fund that functions as a “basket of commodities” and tracks the pricing of physical commodities. Commodity ETFs cover precious metals, agricultural products, crude oil, natural resources, and industrial metals. ETFs differ from other assets because they price and trade like stocks and can help investors benchmark commodities by making them easy to trade and hold.

There are different types of commodity ETFs, so it’s essential to understand which type may be the best fit for your portfolio. Some ETFs focus on one kind of commodity, while others seek to track a diversified commodity index. What assets these ETFs invest in can differ from fund to fund. Some ETFs use futures contracts, while others physically hold and store their assets.

Most often, as an investor, you don't own a physical commodity when you invest in commodity exchange-traded funds. Instead, you invest in contracts that are based on commodity prices.

What to Look for in a Commodity ETF?

Not all commodity ETFs are created equal. Like any investment, there are pros and cons to each ETF you might consider for your portfolio.

On the whole, commodity ETFs are weakly correlated to the stock market, which tends to reduce overall portfolio volatility and can help improve diversification when added to a portfolio. On the positive side, they often offer lower operating expenses than actively managed mutual funds and deliver greater transparency and efficiency for taxable portfolios.

Depending on the issuer, a few characteristics to look for in a potential commodity ETF investment include:

  • Expense Ratio: While most ETFs offer low fees, they vary significantly from product to product. Be sure to review each ETFs’ expense ratio, as high expenses will eat into your profits over time.

  • Assets Under Management: More popular ETFs attract more cash flows and, as a result, will have more assets under management (AUM). A significant amount of assets in an ETF signals trust in the issuer and suggests the fund is unlikely to close from lack of interest.

  • Liquidity: With any ETF, you want to consider its average daily trading volume. Commodity ETFs with higher trading volumes are more liquid and easier for investors to buy and sell at reasonable spreads. Good liquidity is essential if you are considering trading ETFs with algorithmic investment strategies.

  • Structure: It is important to understand how an ETF invests in its underlying commodity. Take GLD, for example. This gold ETF holds physical gold in a vault, pricing the fund based on the total value of those holdings. Another ETF, DBO, invests in futures contracts or derivatives, meaning the fund does not hold any physical commodities.

  • Management: The management style of the ETF can impact fees and investment returns. Passively managed ETFs are often cheaper. But in some cases, such as commodity ETFs that hold futures contracts, active management can be preferable as it allows the underlying fund to deal more effectively with contango and backwardation. Contango is when the futures contract prices are higher than the expected spot price of the asset. On the flip side, backwardation occurs when the current price is higher than what is trading on the futures market.

  • Exposure: For diversified strategies, it is crucial to understand the ETFs’ exposure to each commodity type. For example, how much of the fund is invested in oil compared to gold? Funds with different exposures will have meaningfully different returns.

  • Diversification: One of the benefits of commodity investing is the diversification it can bring to your portfolio, so it’s important to understand how each commodity ETF complements your existing holdings. Backtesting adding commodity ETFs to your portfolio can help you identify which products give you the optimal risk-return profile. Looking at a portfolio’s Sharpe ratio with and without commodities can help you balance total return and volatility. To learn more about backtesting, check out Bringing it Backtesting.

The Best Commodity ETFs

Invesco DB Commodity Index Tracking Fund (DBC)

DBC is a cost-effective and convenient way to invest in commodity futures, tracking the DBIQ Optimum Yield Diversified Commodity Index. The index is composed of futures contracts on 14 of the most heavily traded and important physical commodities in the world. DBC has roughly $3 billion in AUM and invests in futures contracts for WTI crude, natural gas, Brent crude, heating oil, copper, gasoline, silver, soybeans, sugar, corn, and wheat. [1] Launched in 2006, DBC is the most popular ETF option among investors who want broad exposure and return history for backtesting.

Runner-up: iShares S&P GSCI Commodity-Indexed Trust (GSG), which launched shortly after DBC.

Invesco Optimum Yield Diversified Commodity Strategy No K-1 (PDBC)

PDBC uses a similar investment strategy as Invesco's DBC, investing in commodity futures contracts and other financial instruments to provide exposure to the world's most heavily traded commodities. It is also the largest diversified commodity ETF on the market today, with $6.5 billion in assets under management, more than twice that of DBC. [1] Its low expense ratio of 0.59% and simplified tax reporting structure — PDBC invests in its raw materials via a more complex structure designed to avoid K-1 tax forms, which many investors find tricky to manage at tax time — makes this one of the most popular commodity ETFs on the market.

Runner-up: Those looking for a similar tax-friendly approach should also consider iShares GSCI Commodity Dynamic Roll Strategy ETF COMT.

Harbor All-Weather Inflation Focus ETF (HGER)

As an actively managed ETF, HGER does it all. It targets liquid and inflation-sensitive commodities, accounts for inflation, addresses the impact of futures roll yields, eliminates the need for K-1 tax filing, and leverages the expertise of a professional management team actively watching and evaluating the commodities market.

The Composer investment team spoke with Kristof Gleich, Harbor Capital's President, and Chief Investment Officer, about HGER, and this is what he shared:

“Traditional commodity indices and index-based investment offerings typically seek to capture the market from an overall production level, which may not be the best approach when seeking certain outcomes. Alternatively, a skilled and specialized active commodities manager can build commodity strategies based on desired outcomes such as targeting more inflation-sensitive commodities to hedge inflation or renewable energy commodities needed for the transition to cleaner sources of energy”

Investors looking for the steady hand of a seasoned portfolio management team should consider HGER for their portfolio.

Invesco DB Oil Fund (DBO)

Offering direct exposure to the oil market, DBO aims to track the performance of crude oil’s DBIQ optimum yield index. The fund invests in futures contracts for WTI (West Texas Immediate) crude oil. It's the leading benchmark for crude oil in the US. Unlike diversified commodity ETFs, which invest in commodities beyond oil, DBO makes it easy for investors to specifically target this segment of the commodity market.

Runner-up: United States Oil Fund USO.

SPDR Gold Shares (GLD)

Like DBO with oil, GLD offers direct exposure to gold through its holdings of physical bullion. It's the largest commodity ETF on the market with more than $53 billion in AUM, making it a staple in portfolios large and small. Even for non-commodity investors, GLD is a popular diversification tool and core to the Golden Butterfly Portfolio, which invests in an equal-weight portfolio that combines stocks, short- and long-term Treasuries, and gold.

How Composer Helps Investors Pick the Best Commodity ETFs

Investing in commodity ETFs allows you to tap the benefits of this asset class with the convenience of trading equities and without the complications associated with storing physical commodities. ETFs offer low expenses and good liquidity and are an easy way to add diversification to a portfolio.

With Composer, you can:

  • Evaluate the performance of commodity ETFs: How well does the ETF you are considering perform during stock market downturns? What do returns look like during periods of high inflation? Which ETFs are effective inflation hedges? Which commodity index performed the best in 2022? Composer allows you to answer these questions with its powerful backtesting software.

  • Analyze portfolio diversification: An ETF investment strategy is only as valuable if it improves your portfolio. With Composer, you can easily add ETFs in the editor and see the impact on your portfolio’s statistics.

Sign up for Composer today to explore commodity ETFs and simplified algorithmic trading.

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