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How to invest in Commodities using ETF?

ETFs have made investing in commodities cheap and easy for investors of every size and level of sophistication. Before ETFs, if investors wanted to invest in commodities, they had to open up a futures account, get approval from a broker, and maintain margin to cover any movements in the commodities contracts they were holding.

Investors interested in exposure to commodities, with 112 funds available, have a number of options to choose from. They range from physically backed single-commodity funds, such as the SPDR Gold Shares (GLD), to futures-based commodity baskets.

Commodity ETF
Commodity ETF

The two major types of commodity ETFs are (1) those that physically hold a given commodity and (2) those that use futures contracts to gain exposure to a commodity.
Physical commodity ETFs are simple: They store the commodity in a
vault somewhere, and each share represents a certain percentage of the stored commodity. Physical commodity ETFs are currently available only for the precious metals—gold, silver, platinum, and palladium—and baskets of them.

Futures-based commodity ETFs are both more prevalent than physical commodity ETFs (by number, if not by assets) and more complicated. These ETFs hold futures contracts linked to the targeted commodity. Futures contracts are agreements to buy the commodity in question at a future date.

Unlike equities, for which a number of standard benchmark indexes exist that everyone agrees generally represent the market as a whole, there is no consensus on what constitutes a commodity market portfolio.

How to choose the right set of ETF for your portfolio?

Asset Allocation
Asset Allocation

More than a quarter of all ETFs are US equity based. They range from broad-based, total market index offerings to ETFs narrowly focused on, for example, only companies involved in supplying wind power.

Generally three factors play a role in the selection methodology: size of companies (large, small, etc.), style of investment (growth, value, dividend paying, etc.), and sector of the companies (financial companies, transportation companies, etc.).

The primary mechanism through which most equity ETFs are differentiated is by company coverage in terms of size, style, or sector, but within those categories, further distinctions—and performance differences—arise from differences in weighting schemes.

Broadly, the three basic weighting schemes are cap weighting, equal weighting, and “other.”

International equities, with 434 US-listed funds and almost a quarter of the total assets under management, are the most popular type of ETF.

Fixed-income ETFs allow investors to access institutional-level bond portfolios at a scale and cost that were unimaginable at the turn of the 21st century.

Above and beyond these ETF construction issues, the most critical thing to understand about bond ETFs is that, like bond mutual funds,  their behavior differs greatly from that of single bonds.

Because portfolios never mature, the only way to value them is by using the market price for each of the bonds held. Thus, bond funds do not offer principal protection in the way that single bonds can: We are not guaranteed to get our money back at a fixed point in the future.

How to evaluate an ETF to trade

Choosing an ETF
Choosing an ETF

ETFs, like stocks, are accessed on exchanges, through a brokerage account— that is, via financial advisers or institutional sales teams of registered broker/dealers or through on-line transaction services. Trading is one of the largest differences between ETFs and open-end mutual funds, which are purchased and sold once a day at the closing net asset value of the fund holdings.

An ETF has the advantage that it can be purchased whenever  exchanges are open—as well as at closing NAV when a transaction is large enough to qualify for a creation or redemption.

As with all exchange-traded products, ETF investors usually need to pay a commission, however, and incur a trading cost related to the liquidity factors associated with the ETF.

Since 2007 in the United States, ETFs have consistently represented between 15% and 25% of the total dollar value traded when aggregated with equity trading activity.

The 10 largest ETF in volume and AUM are:

  1. SPY – SPDR S&P 500 (US stocks)
  2. IVV Ishares Core S&P 500 (US stocks)
  3. EFA iShares MSCI EAFE (Europe Australasia and Far East)
  4. QQQ Powershares QQQ (Nasdaq 100 trading index)
  5. VWO Vanguard FTSE emerging markets (Emerging markets)
  6. VTI Vanguard Total Stock Market (US Total stock market)
  7. GLD SPDR Gold (Gold bullion)
  8. EEM IShares MCSI Emerging markets (Emerging Markets)
  9. IWM iShares Russell 2000 (Small cap & Mid Cap US Stocks)
  10. IWF iShares Russell 1000 Growth (US Stocks, mid/small cap)

 

How are ETF’s created and sold / marketed?

ETFs are traded on stock exchanges like stocks. Unlike stocks, however, they do not get onto the exchange via an initial public offering.

The only investors who can create or redeem new shares of an ETF are a special group of institutional investors called “authorized participants” (APs).

APs are large broker/dealers, often market makers, that are authorized by the issuer to participate in the creation/redemption process.

The AP creates new shares of an ETF by transacting with the ETF manager.

Each day, an ETF manager publishes a list of securities that it wants to own in the fund.

The list of securities specific to each ETF and disclosed publicly each day is called the “creation basket.”

To create new shares, an AP goes out into the market and buys up all the stocks in the creation basket at the right percentages.

These transactions between the AP and the ETF manager occur in large blocks called “creation units,”.

Most investors, large and small, buy ETFs through their brokers, just as they do a stock. The price those investors pay is based entirely on supply and demand—as with a stock.

Buying ETF
Buying ETF

ETF issuers are required by their exemptive relief from the SEC to contract with third parties to calculate and publish an intraday estimate of the value of an ETF share based on that day’s holdings as disclosed in its creation basket.7 This value is published every 15 seconds and is referred to as the “intraday indicative value,” “intraday NAV” (INAV).

How to invest in Currency though ETF?

Currency ETF
Currency ETF

Currency ETFs have done an excellent job of providing access to a market that was difficult for retail investors to access as recently as a decade ago. In the past, an investor needed a separate account to trade currencies and high minimums were involved. Today, an individual investor can gain exposure to, say, the Swiss franc with less than $100 and a brokerage account.

Since the first currency ETF was launched in 2005, the sector has grown to include 24 currency funds.

Australian dollar
Brazilian real
Canadian dollar
Euro
Chinese renminbi
Indian rupee
Japanese yen
Swedish krona
Pound sterling
Swiss franc

Largest ETF sponsored institutions

ETF’s are managed and offered by companies that have a focus on providing products that help investors get diversification at a much lower cost than a mutual fund. Here is the list of the top companies with the most Assets under management and offerings of ETF.

Company AUM In $ Billion # of ETF
BlackRock 673.2 296
SSgA 379.6 130
Vanguard 351.2 67
Invesco PowerShares 99.9 161
WisdomTree 33.8 62
ProShares 27.4 145
Guggenheim 24.4 68
First Trust 23.9 85
Van Eck 23.4 62
Charles Schwab 19 21
PIMCO 14.6 21
ALPS 9.3 15
Barclays 8.1 80
Northern Trust 7.6 15
Direxion 7.3 55
JPMorgan 5.9 1
UBS 4.4 31
Global X 3.4 40
ETF Securities 3 7
US Funds 2 12

 

Which are the top 20 ETF by Assets Under Management (AUM)?

The largest ETF by amount of money invested in them have a lot more focus on United States Stock market exposure than any other asset class.

ETF visual
ETF visual

If you want to diversify your holdings in the market with exposure to commodities, stocks and bonds, the most diversified portfolio would suffice with investing < 20% each in 5 ETF’s.

SPY SPDR S&P 500 89.9 US equity

GLD SPDR Gold 58.0 Commodities

EEM iShares MSCI Emerging Markets 47.5 International equity

VWO Vanguard Emerging Markets 44.4 International equity

EFA iShares MSCI EAFE 36.8 International equity

IVV iShares S&P 500 25.8 US equity

QQQ PowerShares QQQ 22.1 US equity

TIP iShares Barclays TIPS Bond 19.4 US fixed income

VTI Vanguard Total Stock Market 18.2 US equity

IWM iShares Russell 2000 17.5 US equity

LQD iBoxx $ Investment Grade Corporate Bond 13.1 US fixed income

IWF iShares Russell 1000 Growth 12.6 US equity

MDY SPDR S&P MidCap 400 12.2 US equity

EWZ iShares MSCI Brazil 11.7 International equity

AGG iShares Core U.S. Aggregate Bond 11.2 US fixed income

SLV iShares Silver 10.8 Commodities

IWD iShares Russell 1000 Value 10.7 US equity

IJH iShares S&P 400 MidCap 9.3 US equity

BND Vanguard Total Bond Market 9.0 US fixed income

DIA SPDR Dow Jones Industrial Average Trust 8.7 US equity