Jeffrey L. Stouffer, Principal
Mercantile Capital Group
May 2011
The search for appropriate alternative assets to be used to diversify investment portfolios has created a demand for ‘financial engineers’ to design and bring to the market a wide range of instruments that are promoted as the tool to use.
Commodity Exchange-Traded-Funds (ETFs) fall into this category. The ease of access to ETFs that are identified by their strategy and transparent portfolios, tend to give a false sense of security in addressing the diversification concern through the use of alternative investment strategies. An ETF may be incorrectly chosen as a proxy to the less accessible managed futures asset class.
Commodity ETFs are beta driven instruments that seek to generate returns solely from the market and minimal dependence on manager skill. This places a commodity ETF into a long-only bias and if the ETF uses futures as the vehicle, further complications will result. Commodity futures are derivatives and have a limited lifespan. An ETF that offers futures contracts under the premise that the underlying asset will rise in value, will be subject to an obstacle that is well known to professionals in the futures industry as contango.
