Searching for a Broad Commodities ETF: Avoid GSCI Trackers, Please

by: IndexUniverse

By Matt Hougan

This one's for Dave Nadig: If you’re going to critique my portfolio, please come up with sensible suggestions.

At least you’re making sense when you suggest that I replace my broad-market equity ETF with something from Rob Arnott’s academic finance factory. I may not agree with fundamental indexing in equities, but I can see the argument for it. The performance has been good.

But your commodities suggestion is laughable. The S&P GSCI? Are you crazy?

Not only is the GSCI dramatically overweight energy (70 percent energy exposure!), but it follows an absolutely naive rolling strategy and is one of the worst-performing commodity ETPs in recent history. As the most popular commodity index in the world, it also faces huge front-running risks from hedge funds looking to make a quick buck at your expense.

You should know better, as you actually do know a thing or two about the commodities space.

To my mind, anyone who buys a commodity index fund that blindly rolls using the front-month contract is being lazy. That works in certain types of commodity markets, but not the one we’ve “enjoyed” for the past decade. Contango is a real and calculable cost. Right now, for instance, it’s costing investors in front-month oil futures about 6 percent a year. There’s no reason for investors to give away that 6 percent when alternate strategies are available.

My two favorite commodity ETPs right now are the PowerShares DB Commodity Index Fund (NYSE:DBC) and the UBS E-TRACS CMCI Total Return ETN (NYSEARCA:UCI). The former uses an optimized roll strategy that helps pick the best contract to roll to on a month-by-month basis, and should outperform GSCI-based funds in most market. UCI diversifies across a wide array of futures contracts in an attempt to contain contango, and has been the best-performing commodity index fund since its launch in April 2008.

(UCI is also cheaper than your beloved GSCI-based funds, charging just 0.65 percent in annual expenses. Moreover, as an ETN, it carries certain tax advantages over commodity ETFs.)

For Commodities, Anything But GSC

GSC vs. DBC VS. UCI: April 2008 - July 2010

We could spend days and weeks debating the intricacies of DBC vs. UCI, but it should only take about 10 seconds for you to agree that either is better than a GSCI tracker.

GSCI? Really?

You should know better than that.

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