Commodity ETFs Having Their Moment—Again

Financial advisors, take notice: commodities, one of the areas you were forgiven for ignoring, might be ready to roar back.

Last week, we learned two things about inflation. First, it's sticky at the consumer level and second, it's sticky at the producer level. Is this another "fake out breakout" in this much-maligned market segment? A long-awaited revival of a return-generating asset class that can be a premium inflation fighter? Or something in between?

Inflation has a history of coming back for more, often just as investors conclude it's been conquered. The Consumer Price Index and Producer Price Index data last week essentially said, “just a second," as in here comes a second round of stubbornly high prices.

This potentially complicates the stock market’s glory ride that started 5 months ago. While the “headline” market indicators have produced some of the sharpest upswings in recent history, commodities have spent the past few years swinging. But in their case, the swinging has been in both directions, and the net results are mediocre.

Diversified Commodities ETFs for Sticky Inflation

I picked out three of the larger diversified commodity funds, those which include a basket of derivatives tied to metals, energy and agriculture, the “three amigos” of commodity ETF investing.

Here’s a high-level view of them, and why they might be poised to boost portfolio returns should inflation remain front page news, as it was last week.

The Invesco Optimum Yield Diversified Commodity Strategy No K-1 ETF (PDBC)—let me catch my breath from typing that long fund name—is the biggest fish in this pond, at $4.5 billion in assets under management.

Just the fact that investors have not piled tens of billions into diversified commodities ETFs is a signal that consistently strong returns have evaded commodity investors for a while.

PDBC tracks an index of 14 liquid commodity futures and uses swaps and T-bills in addition to futures to target its benchmark index. It tends to be roughly 50% exposed to energy. That includes oil, gasoline and natural gas.

PDBC, as with many of its larger peers, has produced about an 8%-9% annualized return in the past five years. That should be enough to generate some investor enthusiasm, but when the S&P 500 is clocking in at nearly 15% a year during that time, it is tougher to get “shelf space” in the eyes of investors and advisors. That, and the drawdowns of 50% and 20% that occurred during that period, which might lead some to conclude that they’d be better off having equity exposure and not diversify to get that type of volatility.

FTGC, GSG: Commodity ETFs Tilted Toward Energy

Two other large, diversified commodity ETFs are the First Trust Global Tactical Commodity Strategy (FTGC) and the iShares S&P GSCI Commodity Indexed Trust (GSG).

FTGC is an actively managed ETF, which currently allocates about 35% of assets to energy, 33% to agriculture and the remainder is split among precious metals, industrial metals, and a small allocation to livestock. This ETF ought to distinguish itself if inflation is not overly tied to energy price increases.

Finally, GSG has sprinted to an 11% return to start 2024, putting it near the top of its peer group. Its 57% allocation to energy has a lot to do with that. If someone had invested in any of these three ETFs two years ago, they’d be 1%-5% poorer.

But commodities can be like that. And with inflation potentially reviving as it did in the 1970s, where it moderated and then surged back, advisors would do well to at least keep this market segment on the table.