ETF Expert

The world needs "stuff" like oil, livestock, agricultural products and industrial metals. This stuff goes by another name, "commodities." And smarter, more balanced investors are recognizing the need to have exposure to commodities in their portfolios.

Until recently, getting that exposure wasn’t easy. You had to open an account for trading commodities. And then the question, "Which one?" (You mean speculators were looking at something other than oil?)

Today, however, there are a variety of exchange-traded fund investments. Those who believe oil will continue to rise can choose from the iPath S&P GSCI Crude Oil Index (OIL) and the United States Oil Fund (USO). Those who believe in the strength of steel have the Market Vectors Steel ETF (SLX).

Yet, how do you decide the commodity that is best for you? What if you want broad-based coverage of the "stuff" that the world craves?

For my clients, I have maintained an allegiance to the iPath Dow Jones-AIG Commodity Index Fund (DJP). It offers genuine diversification across all commodities with roughly 30% devoted to energy, 30% to agricultural products, 20% industrial metals, 10% to livestock and 10% to precious metals. Meanwhile, no one area can account for more than 1/3 of the weight in the index.

Lately, though, another index has given me "commodity index envy."  The iPath GSCI Total Return Index Fund (GSP) has produced far superior 1-year returns.

The Goldman Sachs Commodity Index (GSP) is comprised of 24 futures contracts in oil, gas, metals, agriculture and livestock. Its 12-month take is roughly 20% whereas the AIG Commodity Index (DJP) is up about 7%.

An initial reaction to Goldman’s outperformance left me feeling a bit envious. Had I chosen the less vibrant, exchange-traded vehicle?

Then I remembered the main reasons for including commodities in a portfolio: diversification and low correlation. The iPath GSCI Total Return Index Fund (GSP) is primarily an energy play with 75% allocated to oil/gas. You are asking for more volatility with a 75% energy investment that is not genuinely diversified. Again, the iPath Dow Jones-AIG Commodity Index (DJP) restricts a commodity weight to 33%.

Secondly, an investment in a commodity index should exhibit a very low correlation to stock assets. The iPath Dow Jones-AIG Commodity Index (DJP) is virtually uncorrelated to the S&P 500… precisely what one requires when reducing downside risk in an investment portfolio. These are reasons to stick with DJP.

Disclosure Statement: ETF Expert is a web log ("blog") that makes the world of ETFs easier to understand. Pacific Park Financial, Inc., a Registered Investment Advisor with the SEC, may hold positions in the ETFs, mutual funds and/or index funds mentioned above. Investors who are interested in money management services may visit the Pacific Park Financial, Inc. web site.