Commodities gain traction from time to time as an alternative asset class. Their allure lies in their low correlation with traditional investments like stocks and bonds, coupled with their potential to serve as a hedge against inflation.
However, the practicalities of investing in commodities present unique challenges.
The first hurdle is the inherent difficulty in owning physical commodities due to their substantial weight and bulk. Hence, the most feasible method to gain exposure is through futures contracts.
But here lies the complexity: futures contracts are not permanent and require continual renewal—a process known as “rolling forward.” This necessity introduces significant costs that are not often fully appreciated.
In a revealing study, Claude Erb and Campbell Harvey of Duke University scrutinized the S&P GSCI Commodities Index over 15 years. They discovered that the implementation costs using futures roll-forwards were nearly 8% per year, effectively erasing the 3.4% price appreciation of the commodities. This left investors with a disappointing -4.6% return.
Moreover, these numbers don’t even account for the management fees, often around 1%, levied by active managers which can further diminish returns.
For those individual investors still keen on commodities, one low cost alternative is the Vanguard Commodities Index Fund (VCMDX). With a relatively low management fee of 0.21%, this fund provides exposure to commodities by using derivative transactions with prominent Wall Street firms to gain exposure to a broad array of commodities. It does carry one additional risk – counterparty risk.
All things considered, there are not many great alternatives for the average investor to gain broad commodity exposure at low costs. If you are aware of such alternatives, please share.
Erb and Harvey research quoted above is available here
Commodities: Insights and Challenges
in Investing