Futures-Based Commodity ETFs

Abstract

Exchange-traded funds (ETFs) have become popular investments since first introduced in 2004. These funds offer investors a simple way to gain exposure to commodities, which are thought of as an asset class suitable for diversification in investment portfolios and as a hedge against economic downturns. However, returns of futures-based commodity ETFs have deviated significantly from the changes in the prices of their underlying commodities. The pervasive underperformance of futures-based commodity ETFs compared to changes in commodity prices calls into question the usefulness of these ETFs for diversification or hedging. This article examines the sources of the deviation between futures-based commodity ETF returns and the changes in commodity prices using crude oil ETFs. The authors show that the deviation in returns is serially correlated and that a significant portion of this deviation can be predicted by the term structure of the oil futures market. They conclude that only investors sophisticated enough to understand and actively monitor commodity futures market conditions should use these ETFs.

TOPICS: Exchange-traded funds and applications, commodities, futures and forward contracts