There is an ongoing debate about the merits of owning “risky and complicated” futures contracts as compared to owning “simple and convenient” exchange traded funds (ETFs) when you are trying to gain exposure to commodities (or any asset category, for that matter). While the benefits of owning stock index ETFs over stock portfolios have been proven in many studies of active and passive management, there is less evidence of an advantage of commodity ETFs replacing commodity futures portfolios. Even when it comes to taxes, some ETFs send you K-1s versus the “60/40” 1099s sent to commodity futures traders or the regular 1099s sent to stock investors.
Largest commodity ETFs
This analysis compares the returns of the largest commodity ETFs to the returns of the commodity futures contracts represented in each ETF. Each of 15 ETFs (one index and 14 single commodity ETFs) is paired with its corresponding futures contract. In some cases there are multiple ETFs for a single commodity or commodity sector. Only the largest ETFs, by assets under management, were selected for this analysis. In spite of this size criteria, some single-commodity ETFs are very small — perhaps too small for some investors.
Major futures contracts
The futures contracts include 15 major commodities traded on four domestic exchanges:
- WTI Crude Oil
- USLD/Heating Oil
- Henry Hub Natural Gas
- RBOB Gasoline
- High Grade Copper
These futures contracts are traded per the proprietary rules of VistaCTA. They are fully collateralized (unleveraged) shoulder month/back-month futures contracts that are purchased and held for a year, then sold and replaced with a new “back” and “shoulder” month contracts. Shoulder months are the lower volatility “non-high season months” for a given commodity (e.g., April natural gas instead of February) and back months are the lower volatility non-front commodity months (December corn instead of July corn bought in June).
Note that all these futures contracts qualify for inclusion in all the major commodity indexes and commodity index ETFs.
“Comparing apples to oranges,” (below) shows the list of commodity ETFs and their paired futures contracts. Note the DBC, the largest “diversified” commodity portfolio, is compared to the diversified commodity basket.
Futures returns vs. ETF returns
The period chosen for comparison is from Sept 20, 2011 to May 30, 2015. This is the first start date where all the ETFs have commenced trading (mainly the Tecrium grain ETFs). Only the largest diversified commodity ETF and only single-commodity ETFs were chosen to make the cleanest comparison. All returns are computed on a continuously compounded basis. Note this has been a brutally bearish period for commodities and both futures and ETFs are generally down. Finally, the commissions for buying futures and buying ETFs, which do not significantly differ, are not included in the results below.
“Face off,” (below) compares the performance of five major commodity ETFs to their respective commodity futures contracts.
The table in “Inside the numbers,” (below) shows the performance of $1,000 invested on April 19, 2011 in both the futures and the corresponding ETF. In each case, except for GLD, the buyers of commodity futures outperformed the buyers of commodity ETFs.
For example, the buyers of JO, the coffee ETF, had $323 at the end of the period versus a buyer of the coffee futures contract, KC, which ended up at $394. Similar results are shown for soybeans (SOYB $756, ZS $866), crude oil (USO $610, CL $781) and the diversified commodity baskets (DBC $613, Vista $641). Physical gold based GLD is the exception (GLD $658, GC $655). If we replace physical GLD with the largest gold futures-based PowerShares DB Gold ETF, symbol DGL, the terminal value is $629 and the futures slightly outperform. The table also shows terminal VAMIs for all 15 ETFs.
Note that 13 out of 15 ETFs underperform their futures contract.
Risks of ETFs versus Futures contracts
The returns on futures contracts are mostly higher than those from ETFs, but what about risk? Do ETFs have lower risk than holding fully collateralized futures contracts? To address the question and the more complete question of risk adjusted returns, let’s look at the scatter plot of ”daily returns” versus the “standard deviation of daily returns” for each ETF and futures contract. In “Apples to apples,” (below), the ETF’s data points are colored in red and the futures contracts are blue.
In the scatter plot, risk increases as we move to the right on the x-axis and return increases as we move up the y-axis. Only select, extreme data points are labeled. For instance, the natural gas ETF, UNG, has the distinct honor of being the highest risk (2.47%) and second lowest return (-0.12%) commodity investment as displayed by its lower right placement on the chart. In general, ETFs appear as risky or slightly riskier than their respective futures contract. The data for all 15 commodities is in “Risk and returns,” (below).
With futures contracts showing higher returns and comparable or lower risks to ETFs, the case surely can be made that commodity investors may be well-served by holding commodity futures contracts instead of ETFs.
On the downside, commodities appear to be harder to buy than ETFs for smaller investors, this may be the case. Commodity brokers may have higher qualification requirements for futures accounts than exist for securities accounts. If nothing else, these results indicate that the risks of unleveraged, fully collateralized futures appear no greater than those for securities.