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Commodity ETFs

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Although inflation isn’t an issue for most investors at this time, the specter of rising prices continues to haunt the market, especially for those in for the long haul. For these investors, the easy money policies of the Fed, combined with the high budget deficits and enormous debt problems facing the country, suggest that a heavy inflation environment is likely in the not-too-distant future, especially if the U.S. is to avoid the fate of Europe. In order to combat this, many have give portfolios a tilt towards securities that could benefit from a bout of inflation while limiting exposure to securities that have a difficult time passing on costs to end users.  

Inflation-Fighting ETFs

While a sector tilt is one way to approach this issue, one can also fight inflation via a variety of commodity and bond ETFs. While TIPS ETFs as well as funds tracking precious metals are always decent options, they might not—at least by themselves—provide enough diversification in these shaky markets. This is especially true given gold’s recent performance and the incredibly low yield on many American TIPS, suggesting that a broader focus is necessary in order to truly protect against inflation (see Top Three High Yield Junk Bond ETFs).

If you are looking for a diversified option in the space, the relatively new Global Real Return Fund (RRF - ETF report) could be an interesting choice. The fund, from ETF giant WisdomTree (WETF - Snapshot Report), combines a variety of TIPS and commodities and collateralizes the investment with T-Bills in order to give investors a chance to beat out inflation. These securities are either tied outright to the rate of price increases or they are products that are often the first to surge when inflation is rising, suggesting that price increases can be neutralized by this fund, especially when adding in coupon payments (read Australia Bond ETF Showdown).

Real Return ETF In Focus

Currently, the product has about two-thirds of its holdings in inflation-linked bonds with the remainder going towards commodities. However, it should be noted that the product doesn’t limit itself to American TIPS, as inflation-protected securities are in the portfolio from nations such as Australia, Canada, France, Mexico, and South Africa just to name a few. Meanwhile, on the commodity side, exposure is spread across the various sectors with softs, precious metals, livestock, grains, energy, and industrial metals all making an appearance. Furthermore, the product also puts assets in various parts around the futures curve, giving exposure to futures that mature up to four months from now. Lastly, it is important to remember that these commodity holdings are based on both the Commodity Trends Indicator and the Credit Suisse Commodity Benchmark so any alterations to the portfolio’s natural resource component will be largely based on moves in these two benchmarks (read Is USCI The Best Commodity ETF?).

RRF charges investors 60 basis points a year for its services since it debuted in July of 2011. Thanks to ultra-low interest rates around the world and still minimal levels of inflation, the product pays out just 0.02% to investors in 30 Day SEC Yield terms. This low rate along with commodity weakness has caused RRF to underperform benchmarks in 2011 as the product has lost about 4.8% in the past six months. This suggests that RRF has failed to match the rate of inflation over these past months but it could equal or even outperform if bonds—which comprise close to 70% of the portfolio—pay out enough to offset any losses from capital appreciation (read Go Local With Emerging Market Bond ETFs).

Alternatives To RRF

For investors uncertain about RRF based on its performance, there is another option out there for those seeking access to the real return space, the IndexIQ Real Return ETF (CPI - ETF report). This fund, while a bit more expensive than its WisdomTree counterpart, has outperformed RRF so far this year and has done a pretty good job of matching the rate of inflation. The fund has gained 1.5% since the middle of July and 2.3% in year-to-date terms, more or less equaling the current rate of inflation (depending on who you talk to).

This outperformance is likely due to CPI’s focus on short term bonds for its exposure as the product allocates close to 70% of its securities to two ETFs, SHV and BIL. Beyond these two funds, TLT makes up another 11% which likely helps to juice the overall return of the fund. Investors should also note that although CPI has outperformed so far in 2011, it isn’t guaranteed to do so in the future. CPI is much more heavily focused on U.S. securities than its real return ETF counterpart so a great deal of variance will likely be due to the performance of international securities. However, CPI’s more American-focus is likely to push the security to be more in line with U.S inflation, suggesting that for those seeking a global inflation-protected security, RRF could be the better choice despite its subpar performance so far this year (see ETFs vs. Mutual Funds).

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