Specter of Inflation Should Trigger Look at Commodity Exposure

by: , Director, ETF Product Management

Institutional investors have long incorporated commodities in their portfolios as a way to seek true diversification and performance enhancement in various market environments, but they’ve tired of traditional commodities index investing. Most commonly, investors gain commodity exposure through passive futures-based commodity indexes, which have eventually developed into more enhanced index strategies. The reality is that performance among these indexes has generally floundered over the last several years, as they contend with the constant rolling of futures contracts.

An alternative approach to commodity exposure is through equity-linked commodities. Owning equity-linked commodities offers exposures to several commodities that are not traded on futures exchanges, including timber, water, and coal.

Given that the fiscal policies of Donald Trump are likely to be inflationary – a byproduct of a protectionist stance – investors are bracing for the threat of asset erosion. In this setting, commodity-linked equities offer the possibility of positive returns in an inflationary environment.

The chart below illustrates the strong relationship among inflation expectations and natural resource equities.

Natural Resources Have Room to Run

Source: Bloomberg, as of 12/31/16.

Crutch-Proofing Your Commodities Exposure

With traditional futures-based and equity-based commodity indexes alike, the elephant in the room is dependency on oil prices. The main problem with traditional commodity indexes that rely on market capitalizations or production weighting is that the behemoth energy sector is given a majority of the weight. This, in turn, leaves little to no room for truly diversifying across other realms of the commodity sector.

A solution to the inherent flaws of traditional indexing is weighting sectors based on other factors, such as valuation and momentum, allowing for more efficient distribution of weights, which can help achieve more diversified exposure.

The chart below highlights the correlation of several indexes relative to the price of crude oil. Indexes, like the IQ Global Resources Index, take a more innovative approach to weighting securities, and have seen a reduced dependency on oil prices.

Three-Year Rolling Correlation to Crude Oil

Source: Bloomberg, 12/31/16. The performance data quoted represents past performance, which does not guarantee future results. The investment return and principal value of an investment in the Fund will fluctuate, so that an investor’s shares, when redeemed, may be worth more or less than the original cost. Current performance and expense ratios may be lower or higher than the data quoted.

Forgotten Sectors: Don’t Miss Valuable Exposures

Contrary to what many investors may think, the natural resources sector extends its breadth beyond just energy and precious metals. Areas, like water, coal, and timber, play important roles on a global scale, but are often overlooked as part of a core natural resource and commodity allocation. In 2016, sectors, like coal, have witnessed strong rallies, and many traditional commodity products may have little to no exposure to this sector.

Natural Resources Sector Extends beyond Energy and Precious Metals

Sector 2016 Performance Since Commodities Bottom
(02/16 – 12/16)
Coal Equities 99.19% 113.26%
Timber Equities 13.13% 26.87%
Agri-Business Equities 12.51% 19.67%
Water Equities 7.37% 10.13%

Source: Morningstar.

The IQ Global Resources Index will shift sector exposures on a monthly basis, based on a combination of momentum and valuation factors. While many traditional products failed to capture the strong bullish trend in coal, the IQ Global Resources Index maintained a large allocation to coal through 2016, and thus, captured a significant portion of the return.

IQ Global Resources Index: Allocation to Coal

Sources: Bloomberg and IndexIQ.

Investors looking for exposure to natural resources have the tendency to use sub-optimal or inefficient methods, such as futures-based strategies or ones that have significant allocations to energy. Rethinking commodities exposure should include space for considering a multi-factor approach that can offer exposure across broad natural resources equities.

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Index performance is shown for illustrative purposes only and does not predict or depict the performance of the Funds. Indices are unmanaged, include the reinvestment of dividends, and cannot be purchased directly by investors. Past performance does not guarantee future results.

The S&P GSCI® is recognized as a leading measure of general price movements and inflation in the world economy. The index – representing market beta – is world-production weighted. It is designed to be investable by including the most liquid commodity futures, and provides diversification with low correlations to other asset classes.

The DBIQ Optimum Yield Diversified Commodity Index Excess Return™ (the “DBIQ Optimized Yield Commodity Index”) is comprised of notional amounts of each Index commodity, broadly in proportion to historical levels of the world’s production and supplies of the components of the index, inclusive of: Light Sweet Crude Oil (WTI), Heating Oil, RBOB Gasoline, Natural Gas, Brent Crude, Gold, Silver, Aluminum, Zinc, Copper Grade A, Corn, Wheat, Soybeans and Sugar.

The IQ Global Resources Index uses momentum and valuation factors to identify global companies that operate in commodity-specific market segments and whose equity securities trade in developed markets, including the U.S. These segments include Livestock; Precious Metals; Grains, Food, and Fiber; Energy; Industrial Metals; Timber; Water, and Coal. The Index also includes short exposure to global equities as a partial equity market hedge.

Coal Equities are represented by VanEck Vectors™ Coal ETF (KOL®) seeks to replicate as closely as possible, before fees and expenses, the price and yield performance of the MVIS™ Global Coal Index (MVKOLTR), which is intended to track the overall performance of companies involved in coal operation (production, mining, and cokeries), transportation of coal, from production of coal mining equipment as well as from storage and trade.

Timber Equities are represented by Guggenheim MSCI Global Timber ETF (CUT) seeks investment results that correspond generally to the performance, before the fund’s fees and expenses, of the MSCI ACWI IMI Timber Select Capped Index.

The MSCI ACWI IMI Timber Select Capped Index is designed to measure the performance of securities that are engaged in the ownership and management of forests and timberlands and production of finished products which use timber as raw material. The index captures large, mid and small-cap stocks across 23 developed markets countries and 23 emerging markets countries.

Agri-Business Equities are represented by VanEck Vectors™ Agribusiness ETF (MOO®) seeks to replicate as closely as possible, before fees and expenses, the price and yield performance of the MVIS™ Global Agribusiness Index (MVMOOTR), which is intended to track the overall performance of companies involved in: (i) agri-chemicals, animal health and fertilizers, seeds and traits, (ii) farm/irrigation equipment and farm machinery and/or (iii) agricultural products (including grain, tobacco, meat, poultry, and sugar), aquaculture and fishing, livestock plantations, and trading of agricultural product

Water equities are represented by Guggenheim S&P Global Water Index ETF (CGW) seeks investment results that correspond generally to the performance, before the fund’s fees and expenses, of the S&P Global Water Index. The fund invests in companies across all capitalizations.

The S&P Global Water NR Index is comprised of approximately 50 equity securities, selected based on investment and other criteria, from a universe of companies listed on global developed market exchanges, which include water utilities, infrastructure, equipment, instruments and materials.

Consider the Fund’s investment objectives, risks, charges and expenses carefully before investing. The prospectus and the statement of additional information include this and other relevant information about the Fund and are available by visiting www IQetfs. com or calling 1-888-934-0777 Read the prospectus carefully before investing

Risk Discussion: As the Fund’s investments are concentrated in the global resources sector, the value of its shares will be affected by factors specific to that sector and generally will fluctuate more widely than that of a fund which invests in a broad range of industries. The Fund is susceptible to foreign securities risk. Since the Fund invests in foreign markets, it will be subject to risk of loss not typically associated with domestic markets. Loss may result because of less foreign government regulation, less public information, less economic, political and social stability, or other factors. The Fund is exposed to mid and small capitalization companies risk. Stock prices of mid and small capitalization companies generally are more volatile than those of larger companies and also are more vulnerable than those of large capitalization companies to adverse business and economic developments. Since the Fund may invest directly in foreign currencies or in securities that trade in, and receive revenues in, foreign currencies, the Fund is subject to the risk that those currencies will decline in value relative to the U.S. that the U.S. dollar will decline in value relative to the currency being hedged. The ETF should be considered a speculative investment with a high degree of risk, does not represent a complete investment program and is not suitable for all investors.

MainStay Investments® is a registered service mark and name under which New York Life Investment Management LLC does business. MainStay Investments, an indirect subsidiary of New York Life Insurance Company, New York, NY 10010, provides investment advisory products and services. IndexIQ® is an indirect wholly owned subsidiary of New York Life Investment Management Holdings LLC. ALPS Distributors, Inc. (ALPS) is the principal underwriter of the ETFs. NYLIFE Distributors LLC is a distributor of the ETFs and the principal underwriter of the IQ Multi-Strategy Plus Fund. NYLIFE Distributors LLC is located at 30 Hudson Street, Jersey City, NJ 07302. ALPS Distributors, Inc. is not affiliated with NYLIFE Distributors LLC. NYLIFE Distributors LLC is a Member FINRA/SIPC.


Tom Psarofagis

Director, ETF Product Management

Tom was recently a Director, Product Development at Nasdaq where he worked on creating innovative indexes for ETF sponsors. Previously, he was a senior analyst at Avatar Investment Management, a buy-side ETF Strategist

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