WSJ on Innovation in Commodity ETFs

Yesterday the Wall Street Journal ran an article about recent innovation in the commodity ETF space. Our work on commodity ETFs has focused on their use of constant-maturity rolling futures strategies, which incur a roll yield depending on conditions in the futures markets. Now, according to the WSJ, many ETF issuers are choosing more complex strategies to try to mitigate these and other effects in commodities markets:

Some of these new products use complex formulas to identify commodities with the most promising returns. Others place bets that pay off if prices fall as well as rise, a major departure. And in one of the most significant breaks with the past, some funds give managers wider discretion about which materials to invest in than traditional commodity indexes allow...

"You might say it's not indexing," says Matt Hougan, president of ETF analytics at IndexUniverse.com, which tracks funds. "It may be that traditional indexing isn't the best idea in the commodities space."

The funds they mention have a variety of complex features. For example, the PowerShares DB Commodity Index Fund (DBC) uses longer-dated futures contracts to try to reduce negative roll yield. Pimco CommoditiesPLUS Short Strategy (PCCAX) takes short positions, betting that the value of commodities will decline. Some funds, such as Invesco Balanced-Risk Commodity Strategy (BRCAX), and Highbridge Dynamic Commodities Strategy (HDSAX), allow managers to purchase or short a variety of commodities, as well as non-commodity assets such as currencies and swaps.

Some of these strategies, such as the long/short strategies used by the Forward Commodity Long/Short Strategy (FCOMX) and the Rydex SGI Long/Short Commodities Strategy (RYLBX), are commonly employed by hedge funds and options traders, and involve different risks and very specific outlooks as compared to buy-and-hold investments--all the more reason why retail investors should be extra cautious with these and other types of complex ETFs.

(Interestingly, banks have attempted to sell complex commodities strategies to retail investors before. For example, Lehman Brothers sold structured products linked to their extraordinarily complex ComBATS dynamically-allocated commodity strategy just before their bankruptcy in 2008.)