The Rise And Fall Of Commodity ETFs

Purveyors of commodity investing vehicles have long touted the diversification benefits of adding commodity exposure to a portfolio. Indeed, the relatively low correlation of commodities to both stocks and bonds does provide diversification. However, to be truly beneficial to a portfolio, the “diversifiers” should also add to portfolio returns over the long run. For commodities, the long run is often longer than most investors can stomach.

Before the advent of commodity ETFs, commodity investing was outside the reach of the average retail investor. Getting exposure to commodities required opening a futures trading account or joining a private commodity pool. Although those avenues were available, most retail investors chose to forgot those particular options. Instead, stocks (and funds) of oil companies, mining firms, and agricultural companies provided an easier method to gain some exposure to commodities, even though that exposure was indirect and failed to provide the full benefits diversification.

The world changed when the first broad-commodity ETF arrived in February 2006. According to its fact sheet, the PowerShares DB Commodity Index Tracking Fund (DBC) “is designed for investors who want a cost-effective and convenient way to invest in commodity futures. The underlying index is a rules-based index composed of futures contracts on 14 of the most heavily traded and important physical commodities in the world.” Today, it is the largest broad-commodity ETF, with about $1.9 billion in assets.

Although investors could for the first time get exposure to commodities futures as easily as buying a stock, many problems with commodity investing remained. These included the issuing of Schedule K-1s instead of Form 1099s, the inability to track spot prices, fixed-index allocations, and performance.

Since funds like DBC have portfolios of commodity futures contracts, they are not “40 Act” funds regulated by the SEC. Instead, the Commodity Futures Trading Commission has authority, referring to them as commodity pools, and their year-end tax statements arrive as Schedule K-1s instead of the more common Form 1099s. This created unwanted tax headaches for many investors and prompted the invention of new vehicles to help alleviate those headaches.