Here’s why commodity trackers lose you money

October 21, 2009

The Goldman Sachs Commodities Index has done very nicely this year, rising by nearly 45 percent since January 1. So if you had bought a commodity tracker fund then, you’d be pretty happy today, eh? Well, no.

This chart shows that the total return to an investor is a mere 12 percent. Measured since January 2005, the picture is even worse. Despite the boom, which has driven the index up by about 60 percent, our investor will actually have lost about 15 percent of his capital over four years.

In theory, commodity trackers should be as attractive as share index trackers. Pooled funds allow investors to buy an index at low cost, so why not do the same with commodities?

Standard & Poors reckons that $100 billion is invested in commodity tracker funds, and it is only now that the problems are becoming clear. Unlike shares, commodities need space and insurance for storage, so the funds buy the commodities forward, selling them before having to take physical delivery and buying forward again. Because they have strict rules about how and when they roll the contracts, the traders can see the forced sellers (and buyers) coming a mile off, and move their prices accordingly.

This is, effectively, a tax on the fund, and the bigger the fund gets in any one market, the greater the tax the traders can demand to roll its contracts. The result is to guarantee underperformance against the relevant index, and the longer the investment is held, the greater the underperformance will be.

That’s bad enough, but it gets worse: shares produce dividends, so a tracker fund should automatically outperform its basic index simply because of the effect of reinvested dividends. There are no dividends from holding commodities, just the hope of a capital gain on what’s left after the traders have scalped you. They are quite probably employed by the same bank that runs the commodity tracker. 

The moral of this story is that anyone tempted to diversify a portfolio by buying into a commodity fund should lie down until the feeling goes away.


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How many of the investors in tracker funds actually read the prospectus? I remember reading the one for Roger’s commodity fund over 5 years ago and concluded it was such a muddled mess that it wasn’t worth the potential returns.

Posted by Anonymous2 | Report as abusive

Most equity indices are quoted total return – i.e. with dividends reinvested, so it is not correct to say that a tracker should outperform because of dividends solely. Most index trackers actually underperform their total return benchmark. With commodity funds it is also worth noting that the cash collateral backing the futures has to be invested and with many money market funds underperforming their respective benchmarks since the banking crisis, this leads to further underperformance against the relevant commodities index.

Posted by James | Report as abusive

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Posted by uberVU – social comments | Report as abusive

re the remark by James… Most equity indices are quoted total return – i.e. with dividends reinvested”

that’s not my experience, most it seems to me are quoted excluding dividends.

Anyone on here able to confirm the situation for say the UK’s main indicies

Second question. If you buy an ETF which is designed to make money if the index falls ie a short ETF how is the ETF return affected by index dividends ?

Posted by behindthecurve | Report as abusive

Agreed the roll decay is significant. But those investors without tankers, vaults or silos may find the cost bearable to participate.

Posted by Frank Ruffing | Report as abusive

Hey, money people pay out as little as the traffic will bear. If I can make 30 percent on 8 percent money, yey for me. Of course when the commodity takes a dump the investor gets dumped on. Sounds to me like Las Vegas all over again. If you want to make a decent return you have to invest in something tangible, hold it and build it and then take your return. No free lunches today folks.

Posted by f belz | Report as abusive

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Posted by Commodity Trackers, caveat emptor « Quantitative Finance Club | Report as abusive

Most common equity indices are price return, not total return. Brazil’s Bovespa index is a noticable exception.

Posted by Paul Rhodes | Report as abusive