ETF investors gain commodities exposure

Commodities have returned to the structured products spotlight as providers come up with new, more efficient ways of gaining exposure to the asset class and explore innovative ways to package commodity-based investments

paddy-field

The start of 2012 has seen a surge in confidence in commodities, reflected in the launch of a number of exchange-traded funds (ETFs) in January offering both targeted and broad commodity exposure. "Optimism has characterised the commodities market so far this year, as exemplified by the sharp rally in industrial metals," says Michael McGlone, New York-based senior director of commodity indexing at S&P Indices.

The price declines seen last year in industrial metals and agriculture products have led some analysts to view these sectors as having the most potential in 2012, says McGlone. In 2011, industrial metals was the worst performing sector as the S&P GSCI Industrial Metals Index fell 22.33%, but this year the index has led all commodity sectors with an increase of 9.74% in January alone.

"The United Nations projects that around 99% of incremental population growth is going to come from emerging markets," says Graham Day, Chicago-based alternative asset product strategist at Invesco PowerShares. "An increasing population means a higher demand for food and we believe agriculture ETFs are a great way to hedge against rising food prices." We should also see continued interest in base metals, Day adds. "Last year proved difficult, but as China restocks inventory levels and Japan recovers from the tsunami, we could see a jump in demand."

A survey by Barclays Stockbrokers saw 21% of respondents back oil and gas rather than metals as the top-performing sector, but optimism towards the commodities sector as a whole is apparent.

Targeting sectors

In January, BlackRock's ETF platform iShares and Lyxor, the ETF platform of Société Générale, each launched four sector-specific commodity swap-based ETFs that include exposure to industrial metals, agriculture and energy. Both suites were listed on the London Stock Exchange.

The iShares S&P GSCI Dynamic Roll Agriculture Swap, Energy Swap, Industrial Metals Swap and Commodity Swap ETFs all track the S&P GSCI Dynamic Roll Index series, which seeks to mitigate contango by employing a dynamic selection strategy when rolling futures positions. "We have seen sustained interest from professional investors for new commodity exposures," says Axel Lomholt, head of iShares product development for Europe, the Middle East and Africa. "Commodities will remain a key asset class because of low interest rates and their usefulness as both an inflation hedge and a diversification tool."

Lyxor responded to demand for targeted commodities exposure by launching four synthetic sector-specific commodity ETFs. "We have seen a desire not just for broad commodity ETF exposure, but also to focus on the fact that you have different cycles within commodities," says Nizam Hamid, head of exchange-traded funds strategy at Lyxor in London.

Two of the Lyxor ETFs cover agriculture and livestock and the rest industrial metals. All four are based on the S&P GSCI Commodity indexes, which provide long or inverse exposure to a diverse basket of sector-specific commodities. "This is a case of an asset class that you could not replicate in a physical format because you're not allowed to physically own the commodities," says Hamid.

Broad commodity exposure remains the preference for Source and Legal & General Investment Management (LGIM), which partnered to launch the LGIM Commodity Composite Source ETF on the LSE in January. The product is based on the LGIM Commodity Composite Index, LGIM's first, which offers exposure to a selection of commodity indexes.

"We weren't very satisfied with individual commodity indexes and their very different constituents and methodologies, which produce markedly different performance," says Nick Hodges, business development manager and product specialist for index funds at LGIM in London. "But we could see that by combining indexes we could get a better, more diversified approach to investing in commodities."

The idea for the index was driven by demand from pension funds for access to commodities, says Graeme Dewar, head of strategy implementation at LGIM. At launch, it comprises four sub-indexes and will be reviewed at least annually. The LGIM Commodity Composite Source ETF combines physical investment in US Treasuries with a swap overlay, and uses four swap counterparties.

And there are more commodity-based ETFs in the pipeline. On January 13, Invesco Powershares filed with the US Securities and Exchange Commission for an actively managed commodity ETF trust. "The strategy is designed to capture the economic benefit derived from rising or declining price trends in the markets for commodity and commodity-related instruments," according to the filing, and will use between 25 and 35 single commodity indexes.

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