We believe commodity futures offer one of the most direct ways of gaining exposure to the expected demand increase for the materials essential for the energy transition.
Despite this reality, commodity-based equities remain a popular way that investors choose to get exposure to commodities necessary for the energy transition. This largely comes down to misconceptions about the risks in allocating to ETFs holding commodity futures, such as the Harbor Energy Transition Strategy ETF.
Fear of the effect of carry¹ in futures can be a primary reason why many investors avoid futures-based ETFs, but this is largely misunderstood. While the effect of carry in commodity futures has historically been a drag on returns, this has varied significantly by both sector and individual commodity, reflecting storage costs and supply and demand balances. (2)
However, we believe we can expect tighter supply and demand dynamics going forward due to the scarcity of the commodities essential to the energy transition, meaning that it’s reasonable to expect buyers will bid up spot prices (3) due to concerns about limited supply.
The effects of this supply and demand dynamic can outweigh storage costs, resulting in backwardation (4) — where spot prices are higher than deferred, becoming a negative drag (positive addition) to investor returns. This was observed in the S&P GSCI in 2022, as returns outperformed spot prices by nearly 15% between January 1 and November 30.
While investors are wary of the risks of commodity futures, the risks of commodity equities are often understated. Notably, the lower correlation5 of commodity equities and spot prices means the returns of any commodity equity investment are dependent on a number of factors that are not related to the returns of the underlying commodity
Other risks limited to commodity equities include:
- Equity market risk, which arises from sentiment and investment flows broadly impacting equity markets
- Commodity output risk, due to changes in the price of the commodity being produced by the company
- Management risks (financial risk or reputational or legal)
- Commodity input risk if input costs rise for raw materials or labor; and
- Country risks, which arise from the region in which the company operates.
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1) Carry is the return associated with simply holding an investment.
2) Quantix Commodities, LP, December 2022
3) Spot price is the current price in the marketplace at which a given asset can be bought or sold for immediate delivery.
4) Backwardation is the market condition where the price of a commodity’s contract is trading below the expected spot price at contract maturity.
5) Correlation is a statistic that measures the degree to which two variables move in relation to each other.
Investors should carefully consider the investment objectives, risks, charges and expenses of a Harbor fund before investing. To obtain a summary prospectus or prospectus for this and other information, visit harborcapital.com or call 800-422-1050. Read it carefully before investing.
All investments involve risk including the possible loss of principal. Please refer to the Fund’s prospectus for additional risks associated with the Fund. For the Fund’s prospectus and most current performance, please click: RENW
Commodity Risk: The Fund has exposure to commodities through its and/or the Subsidiary’s investments in commodity-linked derivative instruments. Authorized Participant Concentration/Trading Risk: Only authorized participants (“APs”) may engage in creation or redemption transactions directly with the Fund. Commodity-Linked Derivatives Risk: The Fund’s investments in commodity-linked derivative instruments (either directly or through the Subsidiary) and the tracking of an Index comprised of commodity futures may subject the Fund to significantly greater volatility than investments in traditional securities.
Energy Transition Risk: The commodities included in the Index may become less representative of energy transition trends over time and the Fund’s investments may be significantly impacted by government and corporate policies.
The S&P GSCI index measures the performance of general price movements and inflation in the world economy. It is designed to be investable by including the most liquid commodity futures, and provides diversification with low correlations to other asset classes.
Quantix Commodities, LP is the subadvisor for the Harbor Energy Transition Strategy
This article was prepared as Harbor Funds paid sponsorship with VettaFI.
Foreside Fund Services, LLC is the Distributor of the Harbor ETFs.