Commodity ETFs: Does Everyone Need Energy Investment?

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Last week is another strong week that saw strong ascent of commodity ETFs across the board (other than natural gas ETF (UNG)). US Oil (USO) and Silver (SLV) shot up more than 6% while broadbase commodity ETF (DBC) gained 2.56%. For more detailed performance, see here

The unrest in middle east drove oil prices higher again: WTI crude oil reached $104 per barrel. According to an article by Jason Zweig on The Wall Street Journal, $1.4 billion new money was poured into energy related investments in just one week ended on last Wednesday. Speculation is abound. 

A broadbase commodity index ETF usually has adquate energy related exposure. For example, Powershares DB Commodity Index (DBC) has the following weights:

Commodity Contract Expiry Date Index Weight Base Weight
Aluminium 9/21/2011 3.90% 4.17%
Brent Crude 2/14/2012 13.52% 12.38%
Copper - Grade A 3/21/2012 4.24% 4.17%
Corn 12/14/2011 5.47% 5.63%
Gold 8/29/2011 7.03% 8.00%
Heating Oil 5/31/2011 13.70% 12.38%
Light Crude 6/21/2011 12.54% 12.38%
Natural Gas 9/28/2011 4.40% 5.50%
RBOB Gasoline 11/30/2011 13.47% 12.38%
Silver 12/28/2011 2.16% 2.00%
Soybeans 11/14/2011 5.51% 5.63%
Sugar #11 6/30/2011 5.23% 5.63%
Wheat 7/14/2011 5.17% 5.63%
Zinc 5/18/2011 3.65% 4.17%

Energy exposure in DBC amounts to 57.63% as of 3/3/2011!  

In the article, Zweig questioned whether one needs to have energy stocks, especially energy company stocks made up 13% of S&P 500 index. We concur with him that investors should be cautious in the face of such a speculative rush. On the other hand, a portfolio that has commodity exposure can be more diversified and thus, reducing risk and enhancing return in general. This is not necessarily always the case. The following table compares the performance of a portfolio with 5 core assets: US Equities (VTI), Foreign Equities (VEU), Emerging Market Equities (VWO), REITs (VNQ) and Total Bond Index (BND) and a portfolio with an extra asset (DBC). 

Portfolio Performance Comparison

Portfolio Name 1Yr AR 1Yr Sharpe 3Yr AR 3Yr Sharpe 5Yr AR 5Yr Sharpe
Five Core Asset Index ETF Funds Strategic Asset Allocation Moderate 16% 127% 6% 27% 8% 33%
Six Core Asset ETFs Strategic Asset Allocation Moderate 16% 131% 5% 22% 7% 35%

The portfolio with the additional commodity asset slightly under performed. On the other hand, if one adopts a tactical asset allocation strategy, adding the commodity asset will improve the performance and Sharpe ratio: 

Portfolio Performance Comparison

Portfolio Name 1Yr AR 1Yr Sharpe 3Yr AR 3Yr Sharpe 5Yr AR 5Yr Sharpe
Six Core Asset ETFs Tactical Asset Allocation Moderate 15% 110% 11% 83% 15% 102%
Five Core Asset Index ETF Funds Tactical Asset Allocation Moderate 11% 80% 10% 81% 13% 85%


The following table illustrates the trend score among commodity ETFs. 

Assets Class Symbols 03/04
Trend
Score
02/25
Trend
Score
Direction
Silver SLV 46.52% 44.61% ^
Agriculture DBA 18.61% 18.17% ^
Energy DBE 17.6% 17.3% ^
Commodity DBC 16.8% 16.74% ^
Precious Metals DBP 15.95% 15.56% ^
US Oil USO 12.94% 9.09% ^
Base Metals DBB 10.0% 13.17% v
Gold GLD 9.66% 9.84% v
Natural Gas UNG -19.04% -13.96% v

The trend score is defined as the average of 1,4,13,26 and 52 week total returns (including dividend reinvested).


The takeaway is that one can gain energy exposure by investing in broadbase commodity ETF. Investing in a broadbase commodity does not automatically guarantee performance and risk improvement. One has to adopt a tactical (or dynamic) approach to achieve such a goal. 

Symbols:SLV,DBP,GLD,DBB,DBA,DBC,DBE,USO,UNG,VTI,VEU,VNQ,VWO,BND,AGG,SPY,EFA,EEM,IYR,

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Disclosure:

MyPlanIQ does not have any business relationship with the company or companies mentioned in this article. It does not set up their retirement plans. The performance data of portfolios mentioned above are obtained through historical simulation and are hypothetical. 

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