Commodity ETFs: Do They Add Value?

The use of commodities to hedge inflation risk and diversify portfolios is an important component of portfolio management. Most individual investors do not have the assets and/or the expertise to invest directly in commodities. As an alternative, individual investors increasingly have resorted to the use of commodity-based investments such as ETFs. But are they delivering the benefits investors expect? In this article, we evaluate the performance and diversification benefits of equally-weighted portfolios of commodity ETFs from January 2005 through December 2020. We find that the introduction of commodity ETFs has led to a much higher commodity-stock correlation and a moderate decline in commodity-bond correlation. We also compare performance of the commodity ETF portfolio to the US stock market as measured by the S&P 500 ETF (IVV), and to the bond market using the total bond market ETF (AGG). We find that the commodity ETF portfolios have underperformed both the US stock and bond markets and have inferior absolute- and risk-adjusted performance. This inferior performance may be explained by the increase in assets under management in these commodity funds, resulting in an increase in long hedges that shifted the market from normal backwardation to contango. A futures contract in a contango market has a high futures price relative to the expected spot price that would result in a negative expected return. The commodity ETF portfolios, however, outperformed IVV during the 2007 financial crisis—indicating that they are an effective bear market hedge against stocks.