Adding Commodity ETF Exposure to High Yield Income Portfolios Can Enhance Returns

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Includes: DBC, GCC, GSG
by: MyPlanIQ
Income producing ETFs such as high yield stock ETFs and bond ETFs can be used to build a lower risk portfolio for retirement income producing purpose. Previously, we have shown that such portfolios can be built using strategic asset allocation (SAA) or tactical asset allocation (TAA) strategies in a plan called Retirement Income ETFs. In this article, we explore the feasibility of adding commodity ETFs to such a plan.

Retirement Income ETFs with Commodities plan is an extension to Retirement Income ETFs: adding extra commodity asset class with PowerShares DB Commodity Index (NYSEARCA:DBC) and GreenHaven Continuous Commodity (NYSEARCA:GCC). This plan consists of 37 funds. These funds enable investors to gain exposure to 6 major assets: US Equity, Commodity, Foreign Equity, Emerging Market Equity, REITs, Fixed Income. Compared with Retirement Income ETFs, this plan has two additional ETFs that represent the extra commodity asset class.

The following is the comparison between the two plans:

The list of minor asset classes covered by Retirement Income ETFs with Commodities

The list of minor asset classes covered by Retirement Income ETFs

Commodities Broad Basket: DBC, GCC
Diversified Emerging Mkts: EEM, VWO, DEM
Emerging Markets Bond: EMB, PCY
Foreign Large Value: PID, IDV
Global Real Estate: RWX
High Yield Bond: HYG
Inflation-protected Bond: TIP
Intermediate Government: IEI
Intermediate-term Bond: CIU, CORP, MBB
Large Blend: VIG
Large Value: DVY, SDY, VYM, FVD
Long Government: IEF, TLT
Long-term Bond: LQD, VCLT
Mid-cap Value: PEY
Miscellaneous Sector: PFF
Muni National Long: MUB
Muni Short: SHM
Real Estate: IYR, ICF, VNQ
Short Government: SHY
Short-term Bond: CSJ, VCSH
World Bond: BWX, WIP

Diversified Emerging Mkts: EEM, VWO
Emerging Markets Bond: EMB, PCY
Foreign Large Value: PID, IDV
Global Real Estate: RWX
High Yield Bond: HYG
Inflation-protected Bond: TIP
Intermediate Government: IEI
Intermediate-term Bond: CIU, CORP, MBB
Large Blend: VIG
Large Value: DVY, SDY, VYM, FVD
Long Government: IEF, TLT
Long-term Bond: LQD, VCLT
Mid-cap Value: PEY
Miscellaneous Sector: PFF
Muni National Long: MUB
Muni Short: SHM
Real Estate: IYR, ICF, VNQ
Short Government: SHY
Short-term Bond: CSJ, VCSH
World Bond: BWX, WIP
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Asset Class

Retirement Income ETFs with Commodities

Retirement Income ETFs

REITs 4 4
Fixed Income 19 19
Commodity 2 0
Sector Fund 1 1
Foreign Equity 2 2
Emerging Market Equity 3 2
US Equity 6 6
Other 0 0
Total 37 34
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As of Mar 24, 2011, Retirement Income ETFs with Commodities investment choice is unrated and Retirement Income ETFs investment choice is rated as average based on MyPlanIQ Plan Rating methodology that was designed to measure how effective a plan's available investment funds are. It has the following detailed ratings:

Attribute

Retirement Income ETFs with Commodities

Retirement Income ETFs

Diversification great (95%)
Fund Quality No Rating below average (19%)
Portfolio Building No Rating average (50%)
Overall Rating No Rating average (54%)
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The chart and table below show the historical performance of moderate model portfolios employing strategic and tactical asset allocation strategies (SAA and TAA , both provided by MyPlanIQ).

Performance chart (as of Mar 24, 2011)

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Performance table (as of Mar 24, 2011)

Discussions

1. Commodity ETFs are volatile. In fact, PowerShare DB Commodity Index ETF (DBC) lost 32% in 2008 while iShares S&P GSCI Commodity Index (NYSEARCA:GSG) lost a whopping 46% in the same year.

2. Simply adding commodity ETFs to a strategic asset allocation portfolio (buy and hold with regular rebalancing) did not improve the returns in the past five years. This is again due to the big loss incurred in commodity ETFs.

3. Adding commodity ETFs as fund candidates in a tactical asset allocation portfolio, however, can improve returns. In the past five years, Retirement Income ETFs with Commodities Tactical Asset Allocation Moderate had extra 1% annualized return over Retirement Income ETFs Tactical Asset Allocation Moderate.

Coming out of the great recession, governments around the world have adopted loose monetary policies to prop up the economies. These include U.S. central bank's QE2 (Quantitative Easing act 2) and Euro Zone's bailout of troubling peripheral countries like Greece. The current natural disasters in Japan and other countries can only add more demand for the stimulus. These policies resulted in commodity hoarding, especially in material hungry emerging economies such as China.

It is critical to have anti-inflation anti-currency devaluation component. Commodity ETFs are effective tools to cope with the current situations. In a portfolio that is designed to preserve capital for retirement needs. However, because of volatile and somewhat dangerous nature of commodites, one needs to actively manage such a portfolio by adopting tactical asset allocation strategies.

Disclosure: MyPlanIQ does not have any business relationship with the company or companies mentioned in this article. It does not set up their retirement plans. The performance data of portfolios mentioned above are obtained through historical simulation and are hypothetical.

Disclosure: I am long IYR, DBC, DBA.