Futures Free Commodity ETFdb Portfolio

Published on October 18, 2011 | Updated February 10, 2014

Portfolio Strategy

The Futures Free Commodity ETFdb Portfolio is designed for investors who wish to construct a commodity-centric portfolio that avoids holding any futures-based products. This investment strategy may appeal to those who are bullish on commodity prices over the next several years, but wish to avoid the nuances and drawbacks associated with futures-based ETPs. The appeal of investing in commodities stems from the versatility of this asset class; an allocation to commodities can serve as an excellent diversifying agent to any long-term portfolio, potentially enhancing risk-adjusted returns over the long haul. Another reason for why commodities have taken on greater appeal is because of their potential to serve as a hedge against inflation during periods of rising prices; a feat that few asset classes can match. Booming populations and rising levels of urbanization across emerging markets are two key fundamental factors that are also likely to contribute to increasing demand for raw materials and agricultural goods.

The distinguishing factor of the Futures Free Commodity ETFdb Portfolio is that it achieves well-rounded exposure across all of the major commodities without actually investing in any futures-based ETPs. Many popular commodity products invest in futures contracts, allowing for exposure to resources without taking physical possession. We have chosen to avoid this futures-based approach for this ETFdb Portfolio because we believe it’s susceptible to serious drawbacks and costly nuances that can impact bottom line returns. ETPs that invest in futures generally have an automated roll process to avoid delivery on the contracts, so when a contract is about to reach expiration, the fund automatically sells out of the front month and buys in to a future month. However, when futures are contangoed (the futures contracts expiring further into the future are more expensive than the spot contract), this automated roll process will sell low and buy high, erasing gains for its investors and creating a drag on portfolio returns over the long run.

The Futures Free Commodity ETFdb Portfolio delivers futures free commodity exposure by allocating a significant portion of its assets to stocks of commodity producing firms. This approach is appealing to investors for the simple reason that commodity producers are businesses that have a stream of cash flows and dividends associated with them, while commodity futures do not, making them more difficult to value. Investors should keep in mind that while commodity producers may bear a strong correlation with broad equity markets, potentially diminishing some of the diversification benefits associated with this asset class. The Futures Free Commodity ETFdb Portfolio rounds out exposure to precious metals through a physically-backed fund. This portfolio also features an allocation to a one of a kind commodity-centric currency fund, in place of traditional fixed income exposure.

This portfolio may be excessively risky for retired investors with very strict current income needs, but may appeal to risk-tolerant investors who have a bullish outlook on commodities.

  • Risk Tolerance: Moderate-High. This portfolio is subject to more risk than traditional stock/bond portfolios given its rather significant allocation to commodities.
  • Time Horizon: Long. The diversification and return enhancement benefits associated with a commodity-centric investment strategy are generally best realized over the long haul.
  • Current Income Needs: Low-Intermediate. This portfolio lacks traditional fixed income holdings, although its currency component generates a modest current return thanks to its international exposure. 

Portfolio Snapshot

Below are the holdings and allocations for the Futures Free Commodity ETFdb Portfolio. For each ETF included in this portfolio, we have also provided alternative funds that offer similar exposure.

Ticker ETF Asset Type Allocation Expense Ratio Alternative ETFs
HAP Market Vector Hard Assets Producers ETF International Equities 30.0% 0.49%  GNR
LIT Global X Lithium ETF International Equities 10.0% 0.75%  n/a
REMX Market Vectors Rare Earth/Strategic Metals ETF International Equities 10.0% 0.57%  n/a
CROP IQ Global Agribusiness Small Cap ETF International Equities 10.0% 0.75% MOO, BARN
GLTR ETF Securities Physical Precious Metal Basket Shares Commodity 10.0% 0.60% GLD, SLV
CCX Dreyfus Commodity Currency Fund Currency 30.0% 0.55%  CEW
Weighted Average Expense Ratio 0.58%

Historical Return Analysis

Ticker 2009 2010 2011 2012 2013
HAP 42.5% 16.5% -11.7% 8.8% 6.8%
LIT n/a n/a -37.0% 2.7% -9.1%
 REMX n/a n/a -33.9% -10.2% -31.9%
CROP n/a n/a n/a 15.0% 9.2%
GLTR n/a n/a -2.4% 7.6% -28.8%
CCX n/a n/a -3.2% 5.8% -7.2%
Portfolio n/a n/a n/a 5.9% -6.4%
Compare to SPY 26.3% 15.0% 1.8% 16.0% 32.3%
Compare to AGG 3.3% 6.4% 7.7% 3.8% -2.0%

The adjacent table provides historical results for each component of this ETFdb Portfolio, as well as backtested results (as available) for the entire portfolio during 2008, 2009, 2010, 2011, and 2012. The table also shows how this ETFdb Portfolio performed relative to a popular stock market benchmark (SPY) and bond benchmark (AGG).

The majority of the funds included in this Future Free Commodity ETFdb Portfolio have launched in 2011, and as expected historical performance data is quite limited before 2012.

It’s worth noting that commodity producing firms, as represented by HAP, were able to grossly outperform the broad stock market in 2009, while also managing to inch ahead in 2010 and 2012 as well. The market slump in 2008 highlights the importance of including even minimal allocations to fixed income holdings.

Portfolio Expenses

This ETFdb Portfolio is designed for long-term use consistent with a “buy, hold, and rebalance” strategy. As such, minimization of expenses is necessary to avoid return erosion resulting from compounding costs. To this end, we constructed a portfolio with a weighted-average expense ratio of 58 basis points, which is significantly lower than fees charged by actively-managed mutual funds. The impact of this reduced costs structure over the horizon of this portfolio (i.e., the 30 years during which the client will be retired) is significant:

    Growth of $1 Million Over 30 Years @ Annual Return Of:
Portfolio Expense Ratio 5% 10% 15%
Futures Free Commodity ETFdb Portfolio 0.58% $3,661,301 $14,894,310 $56,907,849
Actively-Managed Mutual Fund Portfolio 1.00% $3,243,398 $13,267,678 $50,950,159

Holdings Overview

Below is a brief overview of each component of this ETFdb Portfolio.

  •  HAP: This ETF offers broad global exposure to the largest and most prominent companies engaged in the production and distribution of hard assets.
  • LIT: This ETF tracks the Solactive Global Lithium Index , which is designed to reflect the performance of the lithium industry.
  • REMX: This fund offers diversified exposure to publicly traded companies primarily engaged in the mining, refining, and manufacturing of rare earth/strategic metals.
  • CROP: This ETF gives investors access to small cap companies around the globe engaged in the agribusiness sector, including crop production, livestock operations, and biofuels.
  • GLTR: This fund tracks the Precious Metals Basket Index and provides physically-backed exposure to gold, silver, palladium, and platinum.
  • CCX: This ETF invests in money market instruments in selected commodity-producing countries, including Brazil, Russia, and Australia.

Portfolio Risk Analysis

This ETFdb Portfolio has a fairly high allocation to risky securities given its heavy tilt towards commodity-producers, which can often times behave as leveraged bets on the underlying spot prices. Within the equity portion of this portfolio, the heaviest allocation goes to HAP, which is dominated by “safer” domestic large caps relative to riskier funds like CROP and REMX.


The inherent volatility across commodity producing equities is nicely complemented with a significant allocation to currency instrument CCX, which bears a bond-like risk/return profile, along with exposure to precious metals through GLTR.

Equity Overview

This ETFdb Portfolio contains an allocation of 60% to equities, including both domestic and international stocks. Exposure is spread out evenly across companies of all sizes, with mid caps accounting for the greatest allocation, followed large and giant cap size firms. Large cap equities tend to be more stable than mid cap stocks, but also typically offer less growth potential.

Although correlation between equities of different sizes is strong, the inclusion of small and micro cap equities in this portfolio does offer valuable diversification benefits, as well as exposure to companies more likely to experience significant growth.

The equity portion of this ETFdb Portfolio is heavily focused on commodity-producers given this portfolio’s theme. Investors who are bullish on the global economic recovery may stand to benefit from an investment strategy that allocates a significant portion of its assets to commodity producing firms.

HAP [Fact Sheet]

Investing in commodity producing firms is a common approach that allows for tangential exposure to commodity prices, while still keeping one foot in the equity market. We have chosen to include HAP as our core holdings in this portfolio, as this ETF provides access to a global basket of commodity producers. Its underlying index consists of the largest and most prominent publicly owned companies that are principally engaged in the production and distribution of hard assets.

HAP hold a deep portfolio of approximately 340 securities with a heavy tilt toward giant and large cap stocks. In terms of allocations by commodity family, this ETF focuses primarily on energy and agriculture products, with smaller allocations towards industrial metals and precious metals. Top allocations include several household names likes Exxon Mobil, Potash Corporation of Saskatchewan, and Monsanto. Another reason why we like HAP is because it separates itself from other commodity producing ETFs in the space by employ a unique weighting methodology that is based on consumption and worldwide commodity demand.

LIT [Fact Sheet]

In addition to our core commodity producers holding, we have also chosen to round out exposure across corners of the commodity market that are often overlooked by many. LIT is one of our tactical holdings in this portfolio and it is comprised of companies that are primarily engaged in some aspect of the lithium industry such as lithium mining, exploration and lithium-ion battery production. Lithium has a variety of applications, and is used widely in pharmaceuticals, ceramics, aluminum, and a number of clean technology processes. Lithium is also environmentally friendly and can store three times the energy of competing materials.

LIT holds a shallow, top-heavy portfolio consisting of about 20 companies, with the top ten holdings accounting for the majority of total assets. The holdings in this ETF are fairly well diversified across market cap levels, including a substantial allocation to micro cap companies. Top allocations by country include: United States, Chile, Australia, Canada, France, and Japan.

REMX [Fact Sheet]

REMX is another tactical holding that we have included in the Future Free Commodity ETFdb Portfolio to help round out exposure to less popular segments of the commodity market. This ETF provides indirect exposure to rare earth and strategic metals, which are relatively scarce industrial metals that have more specialized uses and are often more difficult to extract. Strategic metals are used in a variety of technologies including jet engines, hybrid cars, steel alloys, wind turbines, flat screen televisions and cellular phones. Rare earth metals are also essential in many of today’s most advanced electronic technologies.

This ETF holds a basket of 25 companies, although it features a top-heavy construction as the top ten holdings account for about two thirds of the entire portfolio. In terms of market cap, REMX has a focus on smaller mining firms; the top two spots go to miners listed in Australia while the next two are Canadian mining firms. Top country allocations consist of Australia  and Canada, followed by the U.S.  and China.

CROP [Fact Sheet]

We believe that agricultural commodity producers are well positioned to benefit as the global economic recovery picks up, given the favorable demographic trends fueling population growth and demand for food in growing countries across Latin America and Asia. We have included CROP in this portfolio as means of accessing a global basket of companies engaged in the agribusiness sector.

CROP holds a portfolio of about 60 stocks, and roughly two thirds of them are mid cap size companies, while small caps make up the next biggest chunk. Exposure is tilted towards companies that are in the crop production & farming segment, followed by agricultural supplies and logistics. Agricultural machinery and livestock operation firms each account for a  little more than a tenth, while biofuels and agricultural chemicals account for less than a tenth each. Cost conscious investors may also consider MOO, which offers comparable exposure for a cheaper expense fee.

Commodities Overview

For most investors, a significant allocations to commodities in their long-term buy-and-hold portfolios is not appropriate given the fairly high level of risk that is associated with this asset class. However, by staying true to this portfolio’s commodity-centric theme, we believe that this asset class offers a source of uncorrelated returns while also helping to potentially improve risk-adjusted portfolio return over the long-haul.

GLTR [Fact Sheet]

We have included GLTR as it provides the essential exposure to precious metals needed in any commodities-based portfolio. GLTR is a physically-backed commodity product that coincides well with this portfolio’s theme. The fund’s underlying assets are bullion stored in secure vaults, which is an appealing feature that eliminates any nuances related to the use of futures contracts. As compared to commodity futures whose returns can deviate from spot prices, physically-backed products like GLTR have a near perfect correlation with the spot price of the underlying commodities.

Each share of GLTR holds a basket of gold, silver, platinum and palladium in fixed weights: 47.6% of gold, 40.3% of silver, 7.3% of platinum, and 4.8% of palladium. The gold and silver underlying the ETF are held in London, while the platinum and palladium are held in either London or Zurich.

Currency Overview

Many investors shy away from currency investing, influenced by perceptions of extreme volatility and a zero-sum game. While ultra-leveraged forex trading does introduce potential for significant fluctuations, investing in a basket of currencies will generally deliver a relatively stable return, and can add valuable diversification benefits to a portfolio. Staying true to the commodity-centric theme of this portfolio, we have opted for a one of a kind currency ETF that bears a level of risk more closely associated with fixed income holdings.

CCX [Fact Sheet]

One approach to achieving greater exposure to natural resources is by investing in the currencies of commodity-producing countries.  Research shows that a positive correlation exists between the demand for commodities and the currencies of commodity-producing countries: as demand increases, the currency appreciates. We have included CCX in this portfolio since it offers commodity exposure with a currency twist; the ETF seeks to match the total returns reflective of money market rates in selected commodity-producing countries.

A feature of CCX that we find appealing is that the fund’s exposure is nicely split between developed and emerging markets. Holdings include: the Brazilian real, Chilean peso, Russian ruble, South African rand, Australian dollar, Canadian dollar, Norwegian Krone, and the New Zealand dollar. CCX is unique in that it can be best classified as an ultra-short term fixed income product, which creates a risk-return profile that is more comparable to a bond rather than a traditional currency product.

ETF Correlation Matrix

Diversification is a key component of any client portfolio. The adjacent chart shows the correlation between each component of the Futures Free Commodity ETFdb Portfolio.

As is expected, there is a fairly strong correlation between the equity components in this ETFdb Portfolio, including between domestic and emerging market equities. The precious metals exposure in this ETFdb Portfolio adds meaningful diversification benefits, seeing as how GLTR maintains a fairly low correlation with the remainder of the equity holdings. Investors looking to further diversify their holdings and reduce expected volatility ought to consider adding fixed income exposure to this portfolio. 

Disclaimer

The information herein is not represented or warranted to be accurate, correct, complete, or timely. Past performance is no guarantee of future results. All investors should read applicable prospectuses before investing.

From time to time, the authors of this report or other employees of ETF Database may have a long or short position in securities referred to herein. The factual statements herein have been taken from sources we believe to be reliable, but such statements are made without any representation as to the accuracy or completeness or otherwise.[/hide]