Hard Asset Producer ETF (HAP) Under The Microscope

by on March 2, 2010

With the tremendous rise of ETF investing has come the “democratization” of many asset classes previously out-of-reach to all but the biggest and richest individuals and institutions. One of the primary areas of growth in the ETF industry has been commodity products, which have continued to multiply and attract billions of dollars in assets. According to the ETF screener, there are now more than 90 exchange-traded commodity products, including both diversified funds and single-resource funds targeting everything from cotton to tin.

Investors have put these various funds to work in a number of ways, ranging from hedging existing exposure to speculating on changes in spot prices. But some investors have been frustrated by the inherent limitations of certain commodity products, particularly those that employ futures-based strategies. Because funds consisting of futures contracts are impacted by the slope of the futures curve and the efficiency of the “roll” process, they won’t always track the spot prices of the underlying commodities exactly. In some cases the performance gap can be extreme, and many have learned the hard way how contango impacts investment returns.

Some investors have turned to ETFs that invest in stocks of commodity producers as a “contango-free” alternative to futures-based products. There are currently 15 ETFs in the Commodity Producers Equities ETFdb Category, including both broad-based and targeted funds.

One of the more popular and interesting options available to investors in this category is the Hard Asset Producer ETF (HAP) from Van Eck. The fund was developed with Jim Rogers, the legendary investor known as much for his impressive track record as his exotic travel tales. The height of Rogers’ fame came with his work at Quantum Fund, which he started with George Soros and led to several years of impressive returns. Rogers also published several popular (and cleverly-named) books, including Investment Biker and Adventure Capitalist that highlighted his travels to over a hundred countries and a journey of more than 100,000 miles. In recent years, Rogers has become especially bullish on commodities, frequently citing a Yale study reporting that “commodities have outperformed stocks and bonds over a recent 45 year period with less risk, and were a better hedge against inflation.” To bring his investment thesis to the masses, Rogers worked with Van Eck to develop an index that would provide investors with “one stop shopping” to a wide range of commodities in efficient ETF form.

Index

This benchmark to which HAP is linked, the Rogers-Van Eck Hard Asset Producers Index, has several key differences that separate the fund from other commodity producing ETFs. First, in addition to investing in a broad scope of commodities (currently standing at 36 different resources), the fund has allocations to renewable energy and water, a first for this kind of fund. But the biggest differentiator may be the use of consumption-based weights in order to match worldwide commodity demand with the fund’s holdings. As such, HAP focuses primarily on energy and agriculture, which make up about 41% and 30.2% of the fund, respectively, with smaller allocations towards industrial metals (14%) and precious metals (7%). Rogers believes that balancing the fund with consumption patterns offers a solution to what he views as a fault to other funds. “One popular index has 19% in precious metals with only 6% in hydrocarbons – the same weighting it gives orange juice, writes Rogers. “Another recently had as much as 69% in hydrocarbons, with only 31% for everything else the world consumes.”

Holdings

The index on which the fund is based holds 305 individual securities with a heavy slant towards large and mega cap stocks, which make up over 85% of the fund’s total assets. As such, HAP consists of several household names: ExxonMobil, Monsanto, and Potash Corp. of Saskatchewan all get big allocations. Geographically, HAP focuses on North America with about 43% in U.S. stocks and another 13% in Canadian stocks. Other material allocations include about 7% to the United Kingdom and 4% to Australia.

Returns and Fees

Over the past year, HAP has gained more than 65%, as rising commodity prices have boosted profitability of component companies. However, the fund has slumped recently, as a strengthening dollar and concerns over raw material demand in the world’s fastest-growing economies has weighed on prices. HAP charges an expense ratio of 0.65%.

HAP

Verdict On HAP

While achieving commodity exposure through equities has some major advantages, there are also some potential drawbacks. First and foremost, it’s important to keep in mind that HAP’s components are not commodities, but stocks. As such, one of the most-cited benefits of holding commodities–low correlations with traditional asset classes–is somewhat diminished relative to a futures-based approach.

For some investors, exposure to commodity prices through HAP may be preferable, while for others a fund like DBC will be more appropriate. Neither strategy is universally superior to the other, as each offers a unique risk/return profile that may be useful for different objectives.

But for investors seeking commodity exposure through ETFs, it’s nice to have options.

For more reading on hard asset investing, see this report from Van Eck. For more in depth looks as innovative ETF products, sign up for our free ETF newsletter.

Disclosure: No positions at time of writing