For Commodities Exposure, It's CPEs to the Rescue

Back in early January, our team at IndexIQ outlined our top-five ETF-focused trends and insights for the coming year. I’m happy to report that, while no forecast is perfect, we were pretty spot-on regarding commodities. At the time, we stated that we expected investors to continue to shift assets back into commodities due to factors such as a weaker dollar (which was already helping to drive up strong commodity returns) and the need to seek growth through an increasingly diversified portfolio. All the indicators were there, and while we were pretty good at seeing down the pipeline to understand why commodities would likely make sense—which has indeed caused the asset shift we expected—what we didn’t anticipate was precisely how investors would make the move.Now, mid-way through Q2, the picture seems pretty clear: more and more, investors are turning to Commodity Producing Equities (CPEs). Why? Here’s a snapshot of the top three reasons CPEs make a whole lot of sense: 1

Performance

With equity markets at historical highs, many investors are seeking greater diversification—without sacrificing performance. Commodities as a whole offer that desired diversification, but performance typically suffers when commodities exposure is obtained through futures. In contrast, CPEs offer diversification.As I wrote in my blog A Smarter (and Easier) Way to Invest in Commodities, the traditional way to invest in commodities has been through futures, but that old method is quickly giving way to investing not in the complex futures market, but instead in the stocks of the companies that sell commodities. Referred to as Commodity Producing Equities, or CPEs, these securities have been performing markedly better than the futures market.1 In 2015, when commodities were still in a down market, CPEs were down by 20-24%, and while that performance is not much of a selling point for the sector, it’s certainly a much better story than the futures market which was down by as much as 35% in the same period. Even during that time of negative performance, investors seeking to include commodities exposure were gaining using CPEs.2016 provided a much more positive outlook for commodities in general, and CPEs continued to provide upside performance, delivering returns of +20-30%, compared to futures, which returned 10-20%. As we approach mid-year of 2017, those same patterns of relative returns seem to be holding, making performance one of the primary reasons investors are flowing assets into CPEs at record pace.1

Sector concentration

Anyone familiar with commodities futures is all too familiar with the challenges of selecting exposures based on production and/or straight market-cap. While this approach may seem logical from a growth perspective, in the last few years, it has led to an extreme overweighting of energy futures. That’s a problem. Not only have energy futures demonstrated consistently high volatility, but they have also been delivering much lower returns than other commodities—a fact that has dampened the performance of the sector as a whole.1CPEs make it possible to avoid this overweighting by giving investors the ability to focus on specific equities. By choosing to limit the exposure to energy stocks—despite the market cap of the security—and focusing on other commodity stocks that are demonstrating less volatility and higher performance, investors can gain the sector exposure they need to support diversification. 1

Valuation

Many analysts agree that the equity market as whole has reached the potential for over valuation, with estimates now hitting 110% or more of their historical level.1 For investors, that doesn’t leave much room to grow, and it makes the cost of most equities too high for comfort.CPEs, on the other hand, haven’t seen a cost jump. Instead of getting more expensive, CPEs are seeing attractive relative price-to-book/price-to-sales ratios, as well as historical values of about 90%1 For investors, that represents a 15-30% discount on commodity producing equities—a welcome opportunity in a market environment where there are few “sale” prices to be found!I believe the reasons to take advantage of CPEs are clear, and investors are taking notice. Over the last 16 months, aggregated diversified CPE ETFs have seen an average growth of 150%, compared to 13% growth in futures ETFs. And what about those CPEs with large energy weights? They’re not faring nearly as well. In fact, concentrated commodity equities ETFs have seen their assets fall 13% over the same period.1Using ETFs to access CPEs may be a smart way to go, yielding a positive carry instead of the negative carry associated with commodities futures, and delivering the typical advantages of lower costs and higher liquidity. For investors seeking commodities exposure, CPEs can be a great way to get the job done, while also offering the potential for competitive performance, diversified sector concentration, and valuation-driven “sale” prices. By wrapping that already compelling story into an ETF, investors may finally have a robust way to easily and cost-effectively diversify their portfolios with commodities. Click here to learn more about IndexIQ. 1 Bloomberg, as of May 1, 2017.IndexIQ® is the indirect wholly owned subsidiary of New York Life Investment Management Holdings LLC. ALPS Distributors, Inc. (ALPS) is the principal underwriter of the ETFs. NYLIFE Distributors LLC is a distributor of the ETFs and the principal underwriter of the IQ Hedge Multi-Strategy Plus Fund. NYLIFE Distributors LLC is located at 30 Hudson Street, Jersey City, NJ 07302. ALPS Distributors, Inc. is not affiliated with NYLIFE Distributors LLC. NYLIFE Distributors LLC is a Member FINRA/SIPC. Click here to learn more about the IndexIQ.Sal Bruno is a registered representative of NYLIFE Distributors LLC.