Evaluating 'Better Beta' In Commodities

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A lot of exchange-traded products try to beat the market, but it's only in commodities that the more active products are often more popular than their plain-vanilla counterparts.

The most popular basket commodities fund, the PowerShares DB Commodity Index Tracking Fund (NYSEArca:DBC), has over $7 billion in assets under management-more than three times the assets of the iPath Dow Jones-UBS Commodity Total Return ETN (NYSEArca:DJP) and nearly six times the assets of the iShares S&P GSCI Commodity-Indexed Trust (NYSEArca:GSG).

DBC's differentiating factor is mainly that it dynamically picks the futures contracts it holds in an attempt to mitigate contango, which occurs when futures contracts are priced higher than spot with each successive month on the futures curve. This erodes returns, because maintaining exposure means paying more for a new contract than the price fetched for the contract that's about to expire.

In contrast, plain-vanilla products like DJP and GSG simply hold the nearest-to-expire contract on each of their commodities. Every month, as those contracts near expiration, fund managers sell them and buy the new nearest-to-expire contracts.

The idea behind funds like DBC is that they can outperform even an index holding the exact same commodities by being smarter about choosing the right futures contract that will deliver the least contango possible.

Like all funds that have an element of active management, however, they come with active risk; in this case, the risk that the fund manager will pick the wrong contract.

The chart below shows DBC's performance in 2012 against the performance of a front-month "index" I constructed based on single-commodity front-month futures indexes weighted with DBC's current weights.

The ETFs that track dynamic versions of the GSCI also don't differ that much from the GSCI-GSC underperformed the GSCI by about 1.6 percentage points and the iPath Pure Beta S&P GSCI-Weighted ETN (NYSEArca:SBV) underperformed it by about 1.7 percentage points. They're not earning their expense ratios, but they're also not losing much more money than their expense ratios would suggest.

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Copyright ® 2013 IndexUniverse LLC . All Rights Reserved.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , ETFs
Referenced Symbols: DBC , DJP , GSC , GSG , USCI

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