“The more you look at ‘common sense’, the more you realize that it is more likely to be common sense than it is to be knowledge.” —Idriz Shah
It is generally believed that one of the primary utilities of gold in a portfolio is as an inflation hedge.
When you look at the recent price movements of gold, they are not really in line with inflationary expectations. The chart below shows you this clearly. Gold falls short when tracked against the trajectory of the five-year break-even inflation (BEI) rate – a proxy for expectations of changes in the consumer price index.
On a day-to-day basis, the broad-based commodity market has actually been the best tracker of volatility in inflation expectations. It’s a happy medium because of the oil overshoot and gold’s sluggishness.
This leads us to wonder how to most efficiently access the hedging power of commodities. A Baker’s dozen broad-based commodity ETFs exist, but these have been the most active of the year:
Tea iShares S&P GSCI Commodity-Indexed Trust (GSG), launched in 2006, is a first generation portfolio tracking long-established commodity futures benchmark. Although its underlying index is a mix of various front-of-the-month commodities, it is hardly a neutral benchmark. Because it is production-weighted, crude oil, natural gas and other energy contracts make up about 60% of the fund’s commodity exposure. Thus, less time is given to metallurgy, agriculture and livestock. And, Unlike other futures-based portfolios held as a pool, GSG does not hold positions in individual commodity futures contracts. Instead, it only holds the long-dated GSCI Index futures. Open positions in GSG are subject to year-end market rates and gains are taxed at a maximum compounded rate of 27.8%. Shareholders receive Schedule K-1s at tax time instead of Form 1099s.
method behind it United States Commodity Index Fund (USCI) Driving is more dynamic than in GSG. The USCI tracks the Summerhaven Dynamic Commodity Index, an evenly weighted portfolio of 14 commodity futures selected based on their pricing and momentum. The portfolio changes monthly as the seven commodities with the greatest degree of backwardness — or the smallest contango — are tapped for inclusion as well as the seven commodities exhibiting the highest 12-month price movement, provided that With each reorganization yielding at least one precious metal, one industrial metal, one energy commodity, one livestock future, one soft commodity and one grain contract.
“The Somerhaven Dynamic Commodity Index uses a research-based approach to target commodities in a low-inventory state,” says Kurt Nelson, founder and managing partner of Summerhaven Investment Management. “This approach differs significantly from traditional commodity index benchmarks with fixed commodity weights based on liquidity, production and size.” He added that equal weighting helps maximize diversification and lower volatility in his portfolio.
The USCI, like the GSG, is a commodity pool that is subject to year-end market and K-1 tax reporting.
(Contango represents a future curve in which contracts for near-term delivery are priced at a discount to those for subsequent deliveries. The difference in pricing is usually made up of storage and interest costs, which are relatively substantial in supply.) Backward, or reversal, is characterized by near-term delivery at the expense of a premium for deferred contracts and most often exists when supply is tight. The downside of rolling an open futures position into the month ahead Resulting in a roll yield, while in market contango, but a positive yield when the market fluctuates).
Siblings to USCI, the USCF Summerhaven Dynamic Commodity Strategy Number K-1 Fund (SDCI) Claims to be actively managed but uses a methodology similar to USCI to approach its portfolio. Essential distinctions of SDCI include the size and management of its cash component, its dividend policy and, most important, its organizational structure. SDCI is an open-ended ETF, not a commodity pool. That solution is facilitated by its investment in a Cayman Islands subsidiary that actually holds the futures portfolio. As such, shareholders receive a Form 1099 at the end of the year instead of a K-1 return.,
Tea Invesco DB Commodity Index Tracking Fund (DBC) The DBIQ Optimum Yield follows the Diversified Commodity Index, which selects each of its 14 constituent contracts by rolling them into a future month, generating a maximum implied roll yield within the next 13 months. Futures are taken from the energy, precious metals, industrial metals and agricultural sectors. No future livestock is involved. Structured as a commodity pool, profit t . HuhThe market focused on a year-end mark.
DBC’s younger brother, TOho Invesco Optimum Yield Diversified Commodity Strategy Number K-1 ETF (PDBC)employs a Cayman subsidiary to hold its futures portfolio, like USCI, and thus avoids registration as a commodity pool, Primarily an actively managed fund, PDBC’s commodity portfolio is nearly identical to that of DBC, but clearly aims to outperform DBC’s underlying index. As Theodore Samuelowitz, Invesco’s senior portfolio manager for alternative strategies, says, “Every month, we revisit future curves, taking into account market fundamentals, and adjust our positions. This is in contrast to DBC, which once a position is rolled, holds that position ‘up to one month before expiration’.
PDBC shareholders pay taxes on ordinary income and capital gains just as they would with any stock, ETF or mutual fund.
Establishing GSG as a benchmark, a side-by-side comparison of the portfolio’s recent track record allows us to see how their specific organizational structures and management styles affect their effectiveness as an inflation hedge .
The USCF and Invesco portfolio’s brace clearly overcame some of the volatility that GSG exhibited over the past year, resulting in smaller drawdowns and better Sharpe ratios. However, there was a downside cut on some of the uptrend price.
“Both PDBC and DBC use an optimal roll yield method,” says Invesco’s Samuelowitz. “This allows our funds to minimize drawdowns when commodity curves are in contango and capture roll yields when curves are in backwardation. The front-month rolling strategies employed by GSG typically cover higher roll costs. suffer when the markets are in the opposite direction.”
The optimization strategies employed by the USCF and Invesco, along with the ETF structure of an actively managed portfolio of firms, came as a surprise to many holders of SDCI and PDBC in 2021. The 12-month trailing yields were 19.33% and 50.94%, respectively, largely as a result of ordinary income derived from rolls inside the portfolio. As a ’40 Act Fund’, SDCI and PDBC are obliged to pay the profits related to the commodity.
The SDCI realized its advantage by having a very different breed of cat. SDCI’s r-square coefficient versus GSG is significantly lower than that of its direct competitor, PDBC.
“Similar to the S&P GSCI Index benchmark, the DBIQ Optimum Yield Diversified Commodity Index is heavily concentrated in oil, oil products and natural gas,” says Summerhaven’s Nelson. “The remaining non-energy components are limited to only nine commodities with a limited index weighting. Livestock and other major commodities are not included in the DBIQ index. This concentration places significant weighting in traditional carbon-based energy, reducing portfolio diversification. ” It has the potential to increase volatility over time.
Summerhaven’s commodity index, in contrast, is attracted by 27 liquid commodities each month, including six major energy markets and 21 additional commodities such as tin, platinum and lean hogs. “Equal weighting, combined with multiple eligible commodity markets, results in a greater degree of freedom for index return contributions,” Nelson says. “For example, tin was the top performing commodity in 2021, with an annualized return of more than 120%, more than double the return of WTI crude.”
PDBC, for its part, was less volatile than SDCI over the past year and generated a higher return, giving the Invesco portfolio a significant alpha advantage. Nevertheless, the greater price action of the PDBC can be explained by the movements of the GSG compared to the SDCI.
“Most of our commodity allocation is similar to GSG,” explains Samuelowitz, “although GSG is more diversified. The real difference is in the roll pattern. During the pandemic, we were able to further increase our position on the curve intramath in March 2020, Which made a big difference during the volatile summer of 2020. As we progressed through 2020 and oil recovered, we retained some deferred positions but also gave a naturally rebalancing oil market a part of our energy exposure. Goes on the front side of the curve to capture.”
Clearly, there is more to inflation hedge than just owning a property or real estate. All told, the foregoing shows us what is common and what is different in some of the most active broad-based commodity futures portfolios of the year.
The progress of some of these products in reducing volatility and in the production of alpha was by one of America’s best-known entrepreneurs, Henry J. Heinz: “Doing an ordinary thing unusually well leads to success.”
Brad Ziegler is Wealthmanagement’s Alternative Investments Editor. Previously, he was the head of marketing, research and education for the Pacific Exchange (now NYSE Arca) options market and the iShares complex of exchange-traded funds.
