Commodities are essential goods that play the role of ‘inputs’ in the economy. They can also be used as a store of value and a shield from inflation, as in the case of precious metals. For these reasons and others, more investors are entering the commodities market to diversify their portfolios and hedge against inflation. And while there are many ways to break into the market, the use of commodity ETFs is the most popular.
What are commodity exchange-traded funds? Do they work differently from other types of ETFs? Why should you include commodity ETFs in your portfolio? Where can you find them? Which are the best commodity ETFs out there? These and many more questions are what this comprehensive article discusses.
So, if you get into the commodities market using ETFs as your investment vehicle, then this is the guide you need.
Key Takeaways
- The best commodity ETFs to consider include DBC, PDBC, DBE, COMT, SLV, BCI, PALL, and USL.
- As mentioned earlier, this is an extensive piece. But if you are in a hurry, the key takeaways capture the major points in the article.
- From metals to agricultural products and energy sources, the commodities market has proven resilient in recent economic downturns.
- The commodities market also offers attractive benefits to investors, including inflation hedging, reduced portfolio volatility, and diversification.
- Commodity ETFs are exchange-traded funds designed to invest in commodities, including single and multiple commodities or commodities future contracts.
- Commodity ETFs provide easy, simple, and direct exposure to commodities. They are also readily accessible and attract minimal volatility.
- Physical commodities ETFs, equity-based, future-backed commodity funds, and exchange-traded notes exist.
- Each commodity ETF is constructed differently, impacting your risk, returns, and tax situation in various ways.
- The highly liquid nature of commodity ETFs means they are available directly from issuers and stock exchanges.
The Commodity Market
A commodity market trades in the primary economic sector (raw materials) instead of manufactured or finished products. The products in the commodity market are classified as soft or hard commodities. Soft commodities include agricultural products like wheat, livestock, coffee, sugar, and cocoa. Hard commodities include extracted or mined products, such as rubber, oil, natural gas, rubber, gold, silver, and other precious metals. The commodity market can also include a variety of derivative contracts, including futures and swap contracts.
Commodities belong to an asset class that has historically been negatively correlated with other asset classes like bonds and stocks. So, when bonds and stocks struggle, commodities thrive, and vice-versa. That is why investors consider commodities the ideal investment vehicle to diversify their portfolios and hedge against inflation. Perhaps, the only downside of the commodities market before now is the difficulty in accessing it. However, this has ceased to be an issue since the introduction of commodities exchange-traded funds.
Commodity ETFs and Types Explained
A commodity ETF is a stock-traded fund designed to invest most or all of its worth into physical soft or hard commodities. These include agricultural goods, natural resources, and precious metals. An average commodity ETF targets only one commodity (held in physical storage), futures contracts, or tracks the performance of a broad commodity index.
Commodity ETFs offer investors a low-cost and straightforward way to access and invest in the commodity assets class. Compared to investing in futures or stockpiling multiple precious metals in your portfolio, ETFs are simpler, easier to manage, and more readily available. They also attract lower costs and risks and are excellent candidates for inflation edge and portfolio diversification.
Types of Commodity ETFs
There are four types of commodity ETFs: equity ETFs, exchange-traded notes (ETNs), physically-backed funds, and futures-based funds.
Physical Commodity ETFs buy and store the physical commodity themselves. The advantage of this is that it reduces both counterparty and tracking risk. Commodity ETFs in this category often invest in precious metals only.
Exchange-Traded Notes (ETNs) are unsecured debt issued and backed by a bank with a maturity date. They are designed to replicate the returns of an asset by investing in options, bonds, and stocks. They offer a better tax structure, considering you only pay capital gains when the ETN is sold.
Future-based Funds or futures contracts trade on exchanges just like bonds and stocks. They are not physically stored. When the delivery date of a futures contract is close, the holder “rolls” it in exchange for another contract on the same commodity with a future delivery date.
Equity or equity-based ETFs are designed to invest in companies producing, storing, or transporting commodities. Unlike other commodity ETFs, equity ETFs offer more specificity. Investors can focus on particular sectors or multiple companies while saving costs. They are also without the risk associated with physical and futures commodity ETFs.
Moving on, let’s see the best commodity ETFs available to you in the current market.
Best Commodities ETFs To Choose From
While the commodities assets class is still relatively small, you will invest ample time and effort to sieve through to find the right commodity ETFs. Not to worry, you do not have to do all that work; here is a well-researched list of the eight best commodities ETFs you can choose from.
1. Invesco DB Commodity Index Tracking ETF (DBC)
The Invesco DB Commodity Index Tracking ETF (DBC) is the first commodity ETF on this list. It is designed to track the negative or positive changes in the level of the DBIQ Optimum Yield Diversified Commodity Index Excess Return, plus the interest income from the fund’s holdings of primarily US treasury securities and money market income minus the expenses.
Summarily, DBC tracks a basket of 14 most heavily traded commodity futures contracts. Despite focusing 50% of its assets spread across energy-related holdings like gasoline, low-sulfur diesel fuel, and crude oil, it is one of the largest diversified commodity ETFs out there. The other half goes into zinc and a few other base metals and agricultural goods.
DBC has been an impressive performer in the last few years. For example, its index returned 11.71% in the previous five years, 21.21% in the last three years, and 35.08% in the previous year.
DBC was launched in 2006 and currently has an expense ratio of 0.77%.
2. Invesco Optimum Yield Diversified Commodity Strategy No K-1 ETF (PDBC)
Here is another Invesco commodity ETF on our list, the Invesco Optimum Yield Diversified Commodity Strategy No K-1 ETF (PDBC). It is the sister to the first entry on the list—the DBC commodity fund. They both adopt the same investment strategy. However, unlike the direct play involved in DBC, PDBC track the commodities using a complex structure that avoids the dreaded K-1 tax forms.
K-1 forms are required for partnership investments, including several publicly traded stocks and exchange-traded products. PDBC is structured such that any gains or losses investors accrue are not reflected in their personal returns. Instead, they show up on their standard 1099 form. The only downside to this setup is that futures contracts can only make 25% of the fund’s net assets. The rest goes into treasuries and other U.S. debt securities.
PDBC has under management 2x the DBC’s assets, alongside 24 portfolio holdings. It has performed similarly to DBC, with its index returning 11.71% in the previous five years, 21.21% in the last three years, and 24.87% in the previous year.
PDBC was launched more recently in 2014 and has a net expense ratio of 0.62%.
3. Invesco DB MS Energy Fund (DBE)
The Invesco DB MS Energy Fund (DBE) is the third Invesco fund on the list. It is designed to track the positive and negative changes in the level of the DBIQ Optimum Yield Energy Index Excess Return, plus the interest income and minus expenses. The rules-based index comprises futures contracts on some of the most heavily-traded energy commodities in the current market, including crude oil, natural gas, and gasoline.
If you are looking for a commodity ETF that provides specific exposure to futures contracts on fossil fuels, DBE is a top choice. It does so without exposing you to the risks associated with purchasing a futures contract directly. With about $194 million in assets under management and 8.6 million shares, it is one of the most reliable commodity ETFs out there.
Performance-wise, the fund returned an impressive 62.69% in the previous year. The numbers are similar for the last three years (24.96%) and five years (15.83%).
DBE was launched in 2007 as a commodity ETF domiciled in the United States. It has an expense ratio of 0.77%.
iShares is another reputable name in the investment scene, and COMT is one of its two commodity ETFs on this list. The fund is designed to provide investors exposure to commodities through a rules-based futures strategy. It covers the livestock, agriculture, metals, and energy sectors.
The investment objective of COMT is to track the investment results of an index—the S&P GSCI Dynamic Roll Index, which comprises a wide range of commodity exposures with enhanced roll selection on a total return basis. There are 14 commodities in the index, which are selected from the broad groups according to global production levels and commodity prices.
COMT currently has over $2 billion in assets under management. It has returned 12.29% in the last five years and 14.88% in the previous three years. But its most significant return was last year – 40.42%.
The expense ratio of COMT is 0.48%.
The other iShares commodity ETF on our list is the iShares Silver Trust (SLV) ETF. This exchange-traded fund aims to replicate the price performance of the underlying holdings in the LMBA Silver Price. In essence, it seeks to reflect generally the performance of the price of silver.
SLV’s assets, which are majorly silver, are held by JP Morgan Chase. The fund may also keep minimal cash, but only in special situations. SLV is not designed to trade silver directly as a passively managed fund. Therefore, it doesn’t benefit from market price swings. While it sells silver periodically, the returns are solely to cover operating expenses.
SLV has over $14 billion worth of assets under its management and has turned in around 4.5% since its inception in 2006. The average annual return of SLV In the last three years is 9.74%, and 3.86% over the previous five years.
If you are looking for a commodity ETF that exposes your portfolio solely to silver, SLV is one of your best options out there. It is a more cost-effective alternative to purchasing and storing silver.
Its expense ratio is 0.50%.
6. Aberdeen Standard Bloomberg All Commodity Strategy K-1 Free ETF (BCI)
The Aberdeen Standard Bloomberg All Commodity Strategy K-1 Free (BCI) is an exchange-traded fund that seeks to outperform a broad-market commodity index by actively managing its collateral. This index is the Bloomberg Commodity Index Total Return.
Like PDBC, BCI is another commodity ETF on our list that offers investors exposure to the commodity futures without the tax hassle of a K-1 form. It is also actively managed, which protects investors from the negative roll yield problem associated with most passive commodity funds.
BCI was launched in 2017 and has since accumulated over $1 billion worth of assets under management and about 39 million shares. There are 26 commodity futures in BCI’s portfolio, with one to three months maturity periods.
The average annual return of BCI in the last year is 23.07%. The numbers are even better in the previous three and five years; 47.62% and 46.22%, respectively. Its expense ratio is 0.25%.
As the name indicates, the Aberdeen Standard Physical Palladium Shares ETF (PALL) is a commodity market ETF that invests in palladium bullions. Its investment objective is to track the price of physical palladium, i.e., the spot price of palladium minus the trust’s operational expenses.
PALL currently has $347 million worth of assets under its management. In terms of performance, the fund has returned 11.88% in the last ten-year period. The numbers are 16.84% and 6.74% for the last five and three years, respectively. BCI and PALL are issued and managed by the Aberdeen Standard Investments ETFs Sponsor LLC.
If you are in the market for a commodity ETF that gives you a cost-effective and easy exposure to physical palladium, PALL is a suitable option.
Its expense ratio is 0.60%.
8. The United States 12-Month Oil Fund (USL)
The last entry on our list of the top commodities ETFs is the United States 12-month Oil Fund (USL). The investment objective of USL is to track the spot prices of light, sweet crude oil on average of the 12 nearest-month NYMEX WTI crude oil futures contract.
It invests primarily in futures contracts for the light, sweet crude oil and other forms of diesel-heating oil, crude oil, gasoline, natural gas, and other petroleum-based fuels called the Benchmark Oil Futures Contracts.
In this case, the Benchmark Oil Futures Contracts are the futures contracts on light, sweet, crude oil as traded on the New York Mercantile Exchange. The fund has returned 12.64%, 14.92%, and 23.83% in the last five-, three-, and one-year periods, respectively.
The United States Oil Fund ETF is issued by Marygold Cos, Inc. and currently has over $100 million in assets under management. Its expense ratio of 0.88%.
Why Should You Have Commodities ETFs In Your Portfolio?
There are many reasons to include commodities ETFs in your portfolio, but we will discuss the major pointers. Having a portion of your portfolio dedicated to commodities is an excellent move to diversify and hedge against inflation. Furthermore, doing that via ETFs is easier and cost-effective, considering you are not learning how to purchase futures or derivatives.
These funds are also highly liquid and readily available on most stock exchanges. The structural differences of these funds also mean you can laser-focus on one or two commodities or industries. For example, we have agricultural commodity ETFs, single commodity ETFs, and other forms of commodity funds ETFs. The overall risk, return, and tax situations are also much better with commodity ETFs.
Conclusion
Considering how key commodities are to the smooth-running of the economy, it is unsurprising why more investors are eyeing the market. Putting your money into precious metals, agricultural raw materials, and natural gas is a potentially good investment. You are storing value and hedging against inflation while positioning for above-average returns.
The Best Commodity ETF For You
If you have decided to break into the commodities market through ETFs, the next question you want to ask is, which is the best commodity ETF for you? However, there is no definite correct or wrong answer to this question.
No two commodity ETFs are created equally. The difference in structures means you have many options to choose from. You must take time to assess every fund on our list to see which best suit your investment goals and objectives. While at it, focus on the underlying index, investment strategy, historical performance, and expense ratio. Whichever of these funds you end up with, you can rest assured that you are on the right path.
If you find this guide helpful, check out more portfolio and asset reviews on our website.
Good luck!