r2i forum

As I understand it, there are some advantages of investing a small portion of one's AAP in commodities.

My AAP is pretty well diversified across Stocks and bonds and am looking to now throw in some commodity exposure (about 5 - 10 %).

Thought I'd do some initial research on investing in commodities (since I had not done any up until this point) and then ask some questions/suggestions.

So here is my understanding (based on a "crash googling" course :-)) on commodities

Some examples of Commodities include -

Energy components such as crude oil/natural gas
Industrial metals such as aluminium, copper/lead/nickel etc
Precious metals such as Gold/Silver
Agricultural products such as wheat/corn/sugar/coffee
Livestock such as cattle/lean hogs

Some advantages (that I have read about) of investing a small portion of one's AAP in commodities

1) Extremely low correlation with stocks and bonds and therefore a good diversifier
2) While stocks and bonds generally turn south in times of high inflation, commodity investments go up higher.
3) It serves as a hedge to the falling dollar
4) Based on increasing global demand for commodities (key contributors India and China in the future), it "seems" like a good idea

So what options does one have in order to invest in commodities (in the form of ETFs or mutual funds only)?

Extending the idea of indexing (like we do for our stock and bond allocation) to commodities, we can try and invest in a commodities index like for example, the Standard & Poor's Commodity Index (SPCI) or Goldman Sachs Commodity Index (GSCI) or the Dow Jones–AIG Commodity Index (DJ-AIGCI) to name a few.

What are the Mutual funds/ETF's that invest broadly in these commodity indices mentioned above? Some examples are -

1) GSG - iShares S&P GSCI Commodity-Indexed
2) DBC - PowerShares DB Commodity Idx Trking Fund
3) DJP - iPath Dow Jones-AIG Commodity Idx TR ETN
4) GSP - iPath S&P GSCI Total Return Index ETN
5) PCRIX - PIMCO CommodityRealRet Strat Instl (and other such commodity mutual funds)

In comparing the above options, I found the following

# PIMCO, Oppenheimer and other commodity mutual funds - most of them have loads and high expenses or high minimums. Did not find any that really stood out.

# DBC tracks the Deustche Bank Commodities Index and invests in only 6 commodities and is energy heavy (about 53%)

# GSG tracks the GSCI index and invests in 24 commodities, but again is energy heavy (about 74%)

# DJP tracks the DJ-AIGCI index is more diversified than DBC or GSC and is also tax efficient - being an ETN

# GSP tracks the GSCI index and invests in 24 commodities, but again is energy heavy (about 74%). However, this is tax efficient unlike GSG. But it carries Barclay bank credit risk (as compared to DJP)

Based on the above, I am leaning towards DJP based on the fact that it is most diversified and tax efficient (I need to hold it in a taxable account).

I would like to hear opinions from others that have researched and invested in commodity funds/etf/etn. Also, please correct me if I have misstated anything in the notes/research above.

Thank You

P.S - I didnt find a thread that discusses this - if there is one please point me to it.

Some related info and links

explains difference between ETN and ETF

http://www.investopedia.com/articles/06/ETNvsETF.asp



shows breakdown of different commodity indices

http://en.wikipedia.org/wiki/Goldman_Sachs_Commodity_Index

What FP never consider..... has some general info about the reason for investing a small portion in commodities.

I used to suggest commodities via futures before, but given the size of the negative roll yield I do not think they would be a good investment for most people. This does reduce some diversification benefits.

If you absolutely must invest in commodities the approach that is suitable for most people is PCRIX/PCRDX which use futures and TIPS. This is very tax inefficient so it would go into non-taxable accounts.

Vinod