The Last ETF For Your Portfolio?

| About: PowerShares DB (DBC)

Summary

I recently reviewed the Seeking Alpha ETF Investing Guide and decided to implement it for a portion of my portfolio. Previous articles reviewed the first nine ETFs in the guide.

This article reviews the PowerShares DB Commodity Index Tracking Fund, the last ETF in the core portfolio of Seeking Alpha’s ETF Investing Guide.

I am not convinced commodities are necessary for most investors core portfolio. Commodities have long term cycles and the ETF expense ratios are much higher than the other asset classes.

I do not believe energy commodities have bottomed yet but may take a short-term speculative position in commodities in the future.

The Seeking Alpha ETF Investing Guide

I recently reviewed the Seeking Alpha Investing Guide and decided to allocate part of my portfolio to a core portfolio of ETFs, similar to that suggested by the guide. I do not intend to completely switch course from my current allocation but to set up a separate core portfolio of ETFs and to allocate a majority of my investments to this core ETF portfolio over time.

After reviewing the investing guide, I drafted a procedure for implementing the suggestions of the guide. Currently, I am reviewing each of the suggested ETFs to determine which to buy. This article focuses on the commodity portion of the core ETF portfolio and the PowerShares DB Commodity Index Tracking ETF (NYSEARCA:DBC).

PowerShares DB Commodity Index Tracking Fund - Investment Synopsis

The PowerShares DB Commodity Index Tracking ETF seeks to track changes, whether positive or negative, in the level of the DBIQ Optimum Yield Diversified Commodity Index Excess Return plus the interest income from the ETFs holdings of primarily U.S. Treasury securities less the ETFs expenses. DBC is designed for investors who want a cost-effective and convenient way to invest in commodity futures. The index that DBC tracks is composed of futures contracts on 14 of the most heavily traded and important physical commodities in the world. DBC is not suitable for all investors due to the speculative nature of an investment based upon DBC's trading which takes place in very volatile markets. Because an investment in futures contracts is volatile, such frequency in the movement in market prices of the underlying futures contracts could cause large losses.

Long-term performance of DBC compared to the S&P 500

Click to enlarge

Source: Yahoo Finance (2/14/2016)

As the chart above shows, since 2006, DBC and the S&P 500 have not tracked each other very closely and DBC has greatly underperformed the S&P 500. DBC, the blue line, is down 46% compared to the S&P 500, the red line, up 44%. The chart does not include dividends, which would further improve the relative performance of the S&P 500.

5 Year performance of DBC compared to the S&P 500

Click to enlarge

Source: Yahoo Finance (2/14/2016)

More recently, over the last 5 year period, DBC is down 56% compared to the S&P 500 up 39%. Again, the chart does not include dividends, which would further improve the relative performance of the S&P 500.

When setting up a core ETF portfolio and making an initial allocation, an investor may want to consider both the relative historical performance and the expected future performance of commodities compared to the other asset classes covered in the core ETF portfolio.

Performance of commodity indexes and DBC

Source: Invesco PowerShares (as of 12/31/2015)

Commodities peaked in 2008, before bottoming in 2009, then reached a lower peak in 2011 and since then have dropped significantly. Commodity cycles are typically long and I plan to get some additional history to try to ascertain better where we are in this cycle. I do have a general understanding of energy commodities and I do not believe they have reached a bottom yet.

DBC holdings

Source: Invesco PowerShares (as of 12/31/2015)

Over 50% of DBC's holdings are energy related. An investor would want to believe that energy has either made or is near a bottom before investing in DBC. With crude oil production exceeding demand and forecast to continue to exceed demand through at least the rest of 2016, I do not believe the energy commodities have bottomed yet. I have not analyzed agriculture and metals, so do not have a strong feeling for where they are in their cycle.

ETFs in the broad commodities category

Symbol

Fund Name

AUM ($MM)

Expense Ratio

DBC

PowerShares DB Commodity Index Tracking ETF

1,800

0.85%

GSG

iShares S&P GSCI Commodity-Indexed Trust ETF

649

0.73%

USCI

United States Commodity Index ETF

501

1.00%

PDBC

PowerShares DB Optimum Yield Diversified Commodity Strategy Portfolio ETF

243

0.59%

GCC

GreenHaven Continuous Commodity Index ETF

209

0.85%

COMT

iShares Commodities Select Strategy ETF

201

0.48%

FTGC

First Trust Global Tactical Commodity Strategy ETF

160

0.95%

CMDT

iShares Dow Jones-UBS Roll Select Commodity Index ETF

6

0.75%

Click to enlarge

Source: Seeking Alpha (as of 2/14/2016)

Above is a list of the U.S. broad commodity ETFs, listed by assets under management (AUM). As the table shows, DBC is the largest broad commodity ETF by AUM; however, there are four ETFs with lower expense ratios. For those that want to do further research, additional detail on these ETFs is available on Seeking Alpha's ETF Hub.

Expenses

DBC's management fee is 0.85% and estimated futures brokerage expenses are 0.04% for a total expense ratio of 0.89%.

Conclusion

Commodities peaked in 2008, before bottoming in 2009, then reached a lower peak in 2011 and since then have dropped significantly. Commodity cycles are typically long and I plan to get some additional history to try to ascertain better where we are in the cycle. I do have a general understanding of energy commodities and I do not believe they have reached a bottom yet and since approximately 50% of DBC is in energy holdings, it appears early to buy DBC.

I question whether commodities are necessary for most investors core portfolio. Depending on the commodity index you look at, they are down approximately 50% over the last 10 years and much further from their peak in 2008. The expense ratio is also much higher than for any other asset class in the core portfolio, so if you had held this ETF over the last 5 to 10 years, you would have paid a fairly large management expense while you lost the majority of your money.

I have traded energy commodities in the past and I will likely take a short-term speculative position again in the not too distant future. I need to research long-term commodity cycles further before I would consider adding this asset class to my core portfolio and even then, I do not expect to add commodities to my core portfolio.

Addendum

Seeking Alpha's Investment Guide Core ETF Portfolio

ETF Ticker

Fund Name

Fund Description

Expense Ratio

VOO

Vanguard S&P 500 ETF

Large cap U.S. stocks

0.05%

IJH

iShares Core S&P Mid Cap ETF

Mid cap U.S. stocks

0.12%

VTWO

Vanguard Russell 2000 ETF

Small cap U.S. stocks

0.15%

IEFA

iShares Core MSCI EAFE ETF

Multi cap foreign developed market stocks

0.12%

IEMG

iShares Core MSCI Emerging Markets ETF

Multi cap emerging market stocks

0.18%

LQD

iShares iBoxx $ Investment Grade Corporate Bond ETF

U.S. investment grade corporate bonds

0.15%

PLW

PowerShares 1-30 Laddered Treasury Portfolio ETF

U.S. Treasuries

0.25%

SCHP

Schwab U.S. TIPS ETF

U.S. TIPS

0.07%

VNQ

Vanguard REIT Index ETF

U.S. REITs

0.10%

DBC

PowerShares DB Commodity Index Tracking ETF

Broad commodities

0.85%

Click to enlarge

Simply Investing - Philosophy

Establishing a core portfolio in well-diversified, low expense ETFs, held for the long term, is a good idea for most all investors. The core of a small portfolio can start off as simple as one well diversified global ETF with a low expense ratio, like Vanguard Total World Stock ETF (NYSEARCA:VT). Typically, as the portfolio grows, the core of the portfolio would include exposure to the ten asset classes listed above.

There are four steps needed to set up an efficient investment plan. The decisions and actions required to set up the plan and purchase the ETFs can be done in about 4 hours (see the further reading section below for more details):

  1. Decide on an asset allocation plan among the ETFs in the core portfolio.
  2. Open an online brokerage account with a linked online bank account.
  3. Determine if you will invest all your investment funds at once or over a period of time.
  4. Determine which investments to buy in your taxable and tax-deferred accounts.

The core ETF portfolio outlined above, after tax, should significantly outperform either individual stock picking or a portfolio managed by a financial advisor. Over the typical investors time horizon of 40+ years, the expected advantage of this core ETF portfolio is staggering.

Investors that enjoy the investment analysis process and are willing to spend the time to analyze and invest in individual stocks or sectors can still do this. I believe, the majority of these investors should still set up a core ETF portfolio, but can allocate a small, fixed percentage of their portfolio to "edge" positions, which offer additional risk and opportunity.

Further reading

ETF Investing Guide - Written by Seeking Alpha's Founder in 2006 is a great guide for setting up a portfolio of ETFs.

Set Up A Core ETF Portfolio Now - Describes the four steps required to implement the suggestions in the ETF Investing Guide. The ETF Investing Guide is made up of 54 articles and takes some time to read and assimilate the information. This article condenses the information from the guide down to four steps that can be completed to set up a core ETF portfolio in around four hours.

Disclosure: I am/we are long VT.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.