by Al Zdenek
You’re right in recognizing that there are different ways to go about investing in hard asset commodities such as Energy, Metals, Agriculture, Livestock and Meat, and in Currencies, which sometimes are considered a commodity.
The answer to your question depends upon what your objectives are for making the investment and how much money you have to invest. Then, you and your wealth manager need to find which commodities investment strategy and risk/return profile makes most sense for you.
There are two good reasons for an allocation to commodities: diversification and the potential to add to the total return of your core investment portfolio. Historically, commodities have had a low correlation to stocks and bonds. Also, they can offer a potential hedge against inflation and “event risk” situations such as geopolitical turmoil.
Different objectives, different ways
Not all product strategies are the same. Generally speaking, passive commodities investing strategies aim to invest for the Beta, giving exposure that roughly tracks the ebb and flow of the commodities markets, while active strategies invest for Alpha, aiming to generate above-market returns.
ETFs and index mutual funds can offer passive exposure to commodities markets, as can some mutual funds; but be aware that these vehicles emulate an approximation of one particular index or another only. They are not the same thing as the benchmark index they attempt to emulate. So, rather than contain the actual holdings that comprise an index they instead hold futures, options and possibly derivatives whose characteristics approximately emulate the desired benchmark.
Some investors may allocate to companies that mine, drill for or harvest commodities, or are involved in the transmission or distribution of commodities, but equity holdings are not a commodities pure play.
Commodities themselves, however, are traded as futures. So, the typical investor doesn’t take physical delivery of the commodity itself; instead, he looks to make money through the changes in the commodity’s value over time. But don’t try this at home, invest with a professional.
The greater your wealth, the greater your options
There are both managed account and hedge fund vehicles available to accredited investors whose strategies will trade commodities futures and may even take physical delivery of commodities. As with all money managers and strategies, you need to conduct due diligence on the CTA (Commodities Trading Advisor registered with the Commodity Futures Trading Commission) or hedge fund you may consider investing with.
In the world of actively managed CTA and hedge fund commodities investing you’ll find two main approaches employed. One is Directional investing with individual long only and short only holdings. The other is Paired Trade investing where the manager seeks to take advantage of a price difference between markets or instruments.
Learn the manager’s investment approach and analyze the characteristics of his fund because these differ from firm to firm. For example, some managers aim to mute volatility while others are comfortable with it. How about you? If you aren’t comfortable with how one manager invests, and the characteristics of how his portfolio performs, then keep looking for a manager whose process you’re comfortable with.
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