Commodities and K-1s
Commodities haven’t exactly set the world on fire for the last several years, but that may be starting to change. Global synchronized growth – something not seen in the markets for nearly a decade – is starting to look more likely, with the world’s seven biggest economies (the U.S., China, Germany, Japan, France, the U.K., and India) all growing more than 1.5% in 2017, according to the International Monetary Fund (IMF). The IMF is calling for global GDP growth of 3.7% this year, including 4.9% for developing economies.
Growth means demand for resources – oil, copper, and forest products – and growing demand should eventually put upward pressure on prices. We’ve seen that already in the commodities rally that began last year and continued into 2018. This followed several years of significant underperformance for what has always been a volatile asset class.
Is it already too late to invest in commodities? That depends, in large part, of where you think we are in the economic cycle. If we are, in fact, entering a period of global synchronized growth, then commodities should continue to do well. There’s evidence that the asset class actually outperforms, as the business cycle matures. More broadly, some portfolio exposure to the asset class provides diversification, as they have historically shown relatively low correlation to both the S&P 500 and global bonds. What’s more, they are positively correlated to the Consumer Price Index, a measure of inflation that has lately been trending up.
There is no shortage of ways to invest in commodities – futures and options, investing directly in the shares of major commodity producers, buying a herd of cattle – all will provide varying degrees of exposure to the asset class. But, not all these vehicles are alike, some come with complications that the average investor may want to avoid. One of these is what’s known as the K-1, which is used to report a profit and loss in an S Corporation for tax purposes.
For various reasons, many investors would prefer not to have to deal with K-1s (or with some of the other considerations that come along with futures, like “contango” and “roll”). Luckily, there are other ways to get exposure to commodities. One strategy is to build an ETF using companies that can act as proxies for the primary commodities – companies with significant exposure to oil, gold, and water, for example. The extent of the exposure to each commodity would be defined by the rules of the underlying index, as would the weightings to commodity types. By investing in multiple companies, single-stock risk is avoided. Factor-based overlays can be used to further fine-tune the index (and the ETF holdings). By using the ETF structure, trading can take place within the index without investing in futures or creating the need for K-1s.
One of the benefits of ETFs is the ability to invest in more sophisticated strategies and in hard-to-access asset classes, all while seeking to manage risk by constructing a diversified portfolio. Many experts have long advised having some exposure to commodities, but achieving that has not always been easy. Now, ETFs can help with that, too.
All investments are subject to market risk and will fluctuate in value. Past performance is not indicative of future results. An investment cannot be made in an index. Alternative investments are speculative, entail substantial risk, and are not suitable for all clients. Alternative investments are intended for experienced and sophisticated investors, who are willing to bear the high economic risks of the investment. Investments in absolute return strategies are not intended to outperform stocks and bonds during strong market rallies. Hedge funds and hedge fund of funds can be highly volatile, carry substantial fees, and involve complex tax structures. Investments in these types of funds involve a high degree of risk, including loss of entire capital. Treasurys are backed by the full faith and credit of the federal government, as to the timely payment of principal and interest.
Diversification does not ensure a profit or protect against a loss in a declining market.
Neither New York Life Investment Management LLC, its affiliates, nor its representatives provide tax, legal, or accounting advice. Please contact your own professionals.
Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care.
Commodity refers to investments in instruments and companies that are susceptible to fluctuations in certain commodity markets. Any negative changes in commodity markets (that may be due to changes in supply and demand for commodities, market S-4 events, regulatory developments, or other factors) could have an adverse impact on those companies.
Correlation is a statistic that measures the degree to which two securities move in relation to each other.
K-1 income is a tax document used to report the incomes, losses and dividends of a partnership.
S&P 500 is an index of 505 stocks issued by 500 large companies with market capitalizations of at least $6.1 billion.
The information and opinions contained herein are for general information use only. IndexIQ does not guarantee their accuracy or completeness, nor does IndexIQ assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are as of the date of this report and are subject to change without notice. Past performance is no guarantee of future results.
New York Life Investments is a service mark and name under which New York Life Investment Management LLC does business. New York Life Investments, an indirect subsidiary of New York Life Insurance Company, New York, New York 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 Hedge Multi-Strategy Plus Fund. NYLIFE Distributors LLC is located at 30 Hudson Street, Jersey City, New Jersey 07302. ALPS Distributors, Inc. is not affiliated with NYLIFE Distributors LLC. NYLIFE Distributors LLC is a Member FINRA/SIPC.