The 1970s were a legendarily tough decade – for investors, for the UK economy, and for lovers of understated fashion. In his deep dives into the biggest equity swoons and bond market blow-ups, my co-blogger The Accumulator invariably showcases some horror story from the decade that time strives to forget.
Yet as parents and sports coaches alike counsel, it’s from the toughest times that we can draw the biggest lessons.
“High pressure makes diamonds” as people who fire themselves up in the mirror every morning before hitting the M25 like to say.
Which is all good reason to check out the extract from William Bernstein’s new book over on Humble Dollar this weekend.
Once more without feeling
In Courage Required, the veteran investing author reminds us that cheap markets aren’t so easily bought as they appear in hindsight.
Everyone thinks they will buy at the bottom. But in practice you’ll face both practical and psychological roadblocks.
Including Bernstein argues, human empathy:
Empathy […] at least financially, is one expensive emotion, since channeling the fear and greed of others often comes dear.
The corollary to human empathy is our evolutionarily derived tendency to imitate those around us, particularly if they all seem to be getting rich with tech stocks and cryptocurrency.
My own unscientific sampling of friends and colleagues suggests that the most empathetic tend to be the worst investors. Empathy is an extraordinarily difficult quality to self-assess, and it might be worthwhile to ask your most intimate and trusted family and friends where you fit on its scale.
To use a Yiddish word, the more of a mensch you are, the more likely you are to lose your critical faculties during a bubble and to lose your discipline during a bear market.
As somebody who has previously sold some possessions to buy more shares in the midst of bear markets, I’m not sure how to take this.
(Well, I guess I would take it personally, but my apparent lack of empathy protects me…)
Oh well, I’ve always known I think differently. And what equips one poorly for trouble-free dinner party conversation often seems me to be an advantage as an active investor.
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Let’s be clear: leveraged ETFs are hyper-controversial and not well understood. Nevertheless, in forthcoming articles from the Finumus camp about gearing up a portfolio and investing for different generations I intend to talk openly about them.
Hence I want to spend today explaining how they work. That way – with all the blood and gore out and on the table – we can hopefully in future have a grown-up conversation about their use.
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For the final installment of Monevator’s commodities series, I’m going to walk you through my ETF picks for actually investing in this controversial but potentially highly useful asset class.
Of course the recent history of commodities investing has been more troubled than that of an 11-year old arsonist.
We’ve taken four posts just to lay out the pros and cons:
While reasonable minds might disagree on this one, my own conclusion is investing in broad commodities offers me portfolio diversification advantages I can’t get elsewhere.
And now that I’ve researched the available commodities ETFs, I’m satisfied I should be able to pick up a product that can capture the benefits of the asset class, too.
I’ll dive into those details further down.
But first let’s run through my candidates for the best commodities ETFs.
Cumulative nominal GBP return: 9.4% (20 December 2010 to 6 July 2023)
Both these broad commodities ETFs track an index that’s locked on to the fortunes of energy, agriculture, livestock, and industrial and precious metals futures contracts.
That’s a mouthful but it’s what we want to see. (We covered the particulars in a previous commodities investing post.)
Essentially, we want exposure to a diversified range of commodities futures. That’s exactly what we get with these two ETFs.
Here’s the battle of the commodities index trackers across the maximum comparable timeframe:
UC15 (red line) comes in comfortably ahead of CMFP (blue line) with a cumulative return of 18.3% compared to 9.4%.
Though do note the -45% cumulative return chalked up by 2016!
UC15’s better overall return makes it my top pick. But as you’ll see shortly there are reasons you could choose CMFP instead.
There’s certainly no guarantee that UC15 will continue to beat CMFP in the future.
Why did I choose these commodities ETFs?
My main criteria for my best commodities ETF choices are that they:
Track an index that can capture the benefits of the asset class
Have a good long-term track record (relative to mainstream commodities benchmarks)
Have a reasonably low cost
Don’t do anything weird (relative to other broad commodities trackers)
My top two picks tick all those boxes.
I started with the universe of London Stock Exchange broad commodity ETFs listed on justETF, excluding currency-hedged ETFs. As with equities, I want the currency risk associated with commodities (which are denominated in US dollars).
My next stop was to establish which ETFs are doing a decent job of capturing the benefits of the broad commodities market.
My benchmark here is the Bloomberg Commodity Index (BCOM). This is the contemporary version of the investable index I’ve used throughout this series to establish that broad commodities are a worthwhile long-run investment.
(The other well known commodities index is the S&P GSCI, but not a single European ETF tracks it.)
Now, commodities have endured a terrible bear market for most of the period these ETFs have been around. So prepare for your drooling chops to dry when I start bandying around numbers.
Remember we’re here because future expected returns for commodities are estimated to be 3.5% to 4% (annualised real total returns). And because the historical real GBP returns are 4.5% annualised over the past 89 years – trouncing any other asset class that can diversify our equity returns.
Long-term track record
We want our commodities ETF of choice to have matched or beaten the BCOM total return index over the longest possible timeframe.
Both of my top picks launched in 2010, so that’s plenty of time to ascertain whether they work or not.
For comparison, the BCOM total return index delivered a stonking -2.8% nominal cumulative total return (GBP) from 2011 to 2022. (Take me home, mama!)
UC15 earned a 26.7% cumulative return over that period
CMFP earned 21.08%
The point is both ETFs smashed the BCOM return over 12 years.
Which brings me to the next key point…
Your commodities index matters
When you pick a global tracker fund, the index matters, but not that much – just so long as it’s a reputable global equities benchmark.
However we can’t be so complacent with our broad commodities index.
Broad commodity indexes are divided into first generation, second generation, and – oh happy day – third generation iterations.
Second- and third-gen indexes fix some of the known problems with first generation indexes.
Yet the two most popular benchmarks (BCOM and S&P GSCI) are both first-gen originals.
Nonetheless, the changes made in the new indices appear a priori reasonable: less weight in the energy sector; changes in roll schedules (because monthly rolling from nearby to second contract according to the S&P GSCI’s schedule puts one-sided pressure on market prices and causes temporary price distortions that other traders can exploit or avoid); and, increasingly, a shift from holding only the most liquid nearby futures contract toward including a basket of deferred contracts.
That last point is particularly important.
Because first-gen indexes only track the most liquid short-dated contracts, their returns typically suffer in contangoed markets.
Some second-gen indexes mitigate the problem by including contracts further along the curve.
The indexes followed by both UC15 and CMFP use this technique. And these ‘curve management’ strategies actually work, according to Adam Dunsby and Kurt Nelson in A Brief History Of Commodities Indexes:
By distributing positions across the curve, investors have mitigated this impact and achieved higher returns.
Clearly this approach has paid off for UC15 and CMFP as they’ve both easily outperformed the first-gen BCOM index since launch.
You’ve been contangoed
Sadly, we can’t assume the second-gen indexes will always win. As Dunsby and Nelson explain, UC15’s second-gen UBS CMCI index is better in certain conditions:
When contango is more pronounced in the front end of the futures curve, as is typically the case for, say, corn and has recently been the case for crude oil, then these indexes will outperform the first-generation indexes. When futures markets are backwardated, and the backwardation is concentrated in the front end of the curve, then these indexes will underperform the first-generation indexes.
As for CMFP’s BCOM 3 Month Forward index, Dunsby and Nelson say:
The DJ-UBSCI [BCOM] 3 Month Forward takes a different approach. It invests in the commodities contracts that the traditional DJ-UBSCI would hold three months from now.
This feature places all the DJ-UBSCI F3 contracts farther out the futures curve, and since futures curves tend to be flatter as tenor is extended,the effects of backwardation and contango tend to be reduced.
The market tends to switch between backwardation and contango, but contango has dominated returns over the period since most commodity ETFs were launched.
The risk in plumping for UC15 is that we end up kicking ourselves as a golden age of backwardation inevitably follows, simply because we tried to outwit fate.
Neuroticism aside, the more even-handed approach of CMFP could make sense, despite its less impressive overall return, given that predicting the futures curve is well above our paygrade.
Our findings suggest that the enhanced indices retain the risk diversification and inflation-hedging properties of the traditional S&P-GSCI and DJ-UBSCI [BCOM index].
The reason I haven’t given XCMC the nod is because it only launched in November 2021.
That said, the two ETFs have been neck-and-neck over the 20 months XCMC has existed. If you don’t mind a short track record, then choosing XCMC on cost grounds looks reasonable as so far it’s hugging its index as effectively as CMFP.
Personally, I don’t want to exclude agriculture and livestock. But if you do then this is the ETF to consider. It follows the Bloomberg ex-Agriculture and Livestock 15/30 Capped 3 Month Forward index.
Amundi Bloomberg Equal-weight Commodity ex-Agriculture UCITS ETF Acc (CRBL) is a contender and the only broad commodities ETF available that tracks an equal-weighted index. However, the ETF changed its benchmark in January 2023 making it difficult to know whether its long-term returns are still relevant.
Of course, you could always divide your commodities’ allocation between a couple of meaningfully different approaches.
You could split your money 50:50 between a first-gen and second-gen ETF.
Or between a second-gen and the equal-weight ex-agriculture option. Academic research into commodities futures shows that equal-weight indexes have historically outperformed their first-gen counterparts.
It depends on your tolerance for portfolio complexity.
Commodities ETF mop-up
ETFs are not covered by the FSCS investor compensation scheme, although you’d still be eligible for support if your broker went bust.
If you invest outside of your tax shelters then make sure your commodity ETFs have UK reporting fund status. Otherwise capital gains will be taxed at your marginal rate of income tax.
If an ETF’s assets under management (AUM) are worth less than $100 million a couple of years after launch, then it may eventually be closed down or merged with another fund.
That doesn’t mean you lose your money, but it can leave you out of the market for a while, or trigger a tax event – potentially annoying if you’re investing outside an ISA or pension.
Note that my top two ETFs are both comfortably over $100 million in AUM.
Commodities ETFs don’t pay dividends but they do reinvest interest earned on collateral. Consult a tax professional if this concerns you.
I haven’t looked at funds that invest in commodity stocks because they are highly correlated with the broader equities market. You need to invest in broad commodities ETFs to get exposure to the diversification benefits we’ve examined in this series.
Swap shop
Commodities ETFs use total return swaps to track their indexes. A total return swap is a derivative, provided by a third-party who undertakes to pay the ETF the return of the index (minus costs).
This arrangement means commodities ETFs don’t actually invest in futures contracts, never mind shipments full of lean hogs, bales of cotton, or barrels of oil.
Index trackers that use total return swaps are classified as synthetic ETFs and it’s as well to know what that entails.
In reality, each synthetic ETF’s holdings amount to a basket of securities that have nothing to do with commodities and are held as collateral. This is standard practice.
The collateral is there to cover investors against counterparty risk – the chance that the swap provider fails to pay out during some kind of financial crisis.
On that basis, make sure to check that your chosen ETF’s website indicates the tracker is backed by collateral worth at least 100% of its market value.
Commodities ‘coaster
Broad commodities had an awesome 2021 and 2022. But the asset class is hovering around correction territory (-10%) so far in 2023.
If that gives you the heebie-jeebies then commodities are not for you.
They suffer equity-scale volatility and can spend years – even decades – underwater.
Eruptions into positive territory can be brief but spectacular, like watching the geyser Old Faithful blow its spout in Yellowstone Park.
But there’s no point investing in commodities if years of negative returns turn you into Old Unfaithful – ditching your holding and so failing to collect when returns sky rocket.
Personally, I’m still nervous about commodities. But I’ve been persuaded by the long-run data that shows the asset class can work when others fail.
For this reason, I’m going to take the plunge now I’ve homed in on a couple of commodities ETFs that look up to the job.
That said, I will proceed cautiously. I’ll start by switching a few percentage points of asset allocation, then build up my position slowly over the next couple of years, or whenever the market takes a downward lurch.
With commodities – more than my other asset classes – I want to minimise any early regrets, get comfortable, and then hunker down for the long-run.
You won’t find anything more ridiculous, than this new profile
Razor unit, made with the highest British attention to the
Wrong detail, become obsolete units surrounded by hail.
A side theme of this blog over the past few years – much more in these weekend rambles than our investing articles – is that Britain is not the super-rich country it’s been acting – and voting – like it thinks it is.
Not as experienced by the average Briton anyway.
It’s not only me. Contributor Finumus believes the same. The Accumulator largely keeps politics out of his articles as much for his blood pressure as to maintain the peace. And several of our most respected regulars in the comments have made the same point.
By GDP per capita, adjusted for purchasing power, the US ($76,399) is 39% richer than the UK ($54,603). GDP growth since 2010 has been 47% faster – nine percentage points – in the United States (28% growth) than the UK (19% growth), despite being from a much higher level.
France / Germany were much closer to the US than to the UK at $69/hour.
Between 2010 and 2019, productivity growth was twice as fast in the US (8% growth) as the UK (4% growth).
Americans could stop working each year on September 22nd and they’d still be richer than Britons working for the whole year.
Or, as Mike Bird pointed out, a car wash manager at an Alabama Buc-ees, a chain of gas stations and grocery stores, earns more ($125k/year) than THREE median UK salaries.
The average starting salary for a newly-qualified nurse in the US is over £42,000, compared to only £27,000 in most of England, and the gap only widens as their careers progress.
Read Bowman’s piece to hear what he thinks we should be doing it about Britain’s semi-stagnation.
Spoiler alert: it’s nothing like what we have been doing for the past seven years.
Anglosceptics anonymous
I don’t agree with all that ex-Adam Smith Institute director Bowman writes, though his dour prognosis on the economic consequences of Brexit in 2017 pretty much mirrored mine.
In particular I’m more concerned about the consequences of fossil fuel burning than he appears to be here, though I seem to recall he sees cheaper energy today as a faster path to us being rich enough to afford a renewable grid. (I might be misremembering).
Also Bowman’s bullet point drive-by comparison would be even deadlier if it didn’t focus so much on the US. The 20th Century was the American Century. With its tech company dominance over the past 25 years, who’s to say the 21st won’t be too? It’s an unrealistic benchmark for Britain.
Still, it’s refreshing to read a right-of-centre summary that mostly describes Britain in 2023 as I would. Seemingly ex-growth, in the jargon of stockpickers, and possibly a value trap.1
Things can always get better. But change starts with admitting that we – especially the young – have a problem.
I mean big picture Britain here, not the London stock market. Despite a little bounce over the past few days on lower inflation and a weaker pound, for the very little it’s worth I agree with those who think the UK market looks relatively cheap. [↩]
