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A Different Twist on Commodity ETFs

Paul Justice, CFA

Paul Justice: Commodity funds based on futures strategies have performed pretty poorly over the last three years but investors are still seeking their commodity exposure in the ETF arena. Joining me today is Kevin DiSano of IndexIQ, to have a discussion about their global resources fund. Thank you for joining me today, Kevin.

Kevin DiSano: Thanks Paul.

Justice: Now your fund gives you commodity exposure but through a different route, rather than owning futures contracts and rolling those on a month by month basis. Could you give us a description on how you gain commodity exposure?

DiSano: Sure. The global resources fund is designed to solve for a lot of the major issues as you've pointed out. It invests across eight different sectors and it uses the equities in those sectors in the commodity space to gain exposure.

Justice: Sure. So the commodity producers themselves. Now, when people think of commodity investing from an asset allocation perspective, very rarely do they consider the equities because they're highly correlated with stocks themselves. They are stocks!

DiSano: Right.

Justice: How do you go about addressing that issue?

DiSano: Yes, we noticed that there was definitely some correlation issues when you go into the equity market. Interestingly, the equities correlate with both the commodity market and the equity market. So what we wanted to do was isolate as much of that commodity exposure as possible and so we've built into the portfolio a 20% short position, 10% to the S&P and 10% to the EFA. Being a global equity portfolio, we wanted to take out some of that equity beta and isolate the underlying commodity exposure.

Justice: Sure. So that's really the basis of the IndexIQ Global Resources Fund. The ticker on that is GRES, G-R-E-S?

DiSano: That's right, G-R-E-S. I think the other thing with respect to the portfolio that's of note is it's not market-cap weighted. So what you get is a portfolio across the eight resource sectors, which is actually the most diversified in the market place. So in addition to the standard energy and precious metals, you also have coal, timber, water stocks in the portfolio, which also adds to diversification and it doesn't give you an overweight in gold and oil in particular.

So the portfolio certainly could be over weighted in those areas if the fundamentals warrant it but in the way the portfolio's designed, it's designed to rotate across the eight sectors based on valuations and momentum. The index is actually re-weighted monthly to do that.

Justice: And how does the fund perform relative to kind of the spot markets in commodities?

DiSano: Well, it's interesting, you know. Obviously it's time-frame dependent but if you just look at the year to date performance of some of the broader spot commodity indexes that use the futures contracts, the portfolio's held up much better than those. I think that's a function of two things. Number one: obviously the equity exposure helped for the first four months of the year and the short hedge has obviously helped here recently, in addition to the fact that the portfolio is not overweight oil.

Energy was actually a very modest weight in the portfolio relative to what you're seeing in some of the spot or futures related strategies, I should say. So I think those are the major reasons why the strategy has performed well, really over the last two-plus years.

Justice: No, it's a very interesting time in commodity investing. There's so much financial interest in the futures markets compared to where we were just a few years ago, which I would argue is making them very inefficient for gaining commodity exposure. So, this seems like a decent workaround for people who are still looking for that commodity exposure, either from asset allocation or speculation for possible inflation or general price instability. You know, the "bad word" deflation coming down the road.

I appreciate you sharing your insights on the fund with us today. I'm Paul Justice for Morningstar. For this and more information on ETFs, please check out our ETF investor newsletter or Morningstar's ETF solution center.