Introduction

Commodity ETFs invest in a basket of commodities including agriculture, natural resources and precious metals.

Under the UCITS framework, commodity indices that ETFs track must be at least as diversified as equity benchmarks.

Replication methodologies

Commodity ETFs offer their exposure by tracking swaps or investing physically in the underlying assets rather than investing in futures contracts directly which would contravene UCITS rules.

The WisdomTree Broad Commodities UCITS ETF (PCOM), for example, invests in a combination of synthetic and physical exposure. Precious metals such as gold and silver are physically held by PCOM while swaps are used to deliver the performance of energy agriculture and industrial metals.

A swap contract is a financial derivative agreement between two parties to exchange – or "swap" – financial instruments or cash flows at predetermined terms over a specified period.

The Invesco Bloomberg Commodity UCITS ETF (CMOD), for example, holds US Treasuries and uses unfunded swaps, where approved counterparties exchange any difference between index returns and a rate tied to the US Treasuries held by the ETF.

CMOD, which is the largest commodity ETF in Europe, tracks the Bloomberg Commodity index of 23 commodities including energy, agriculture, livestock, industrial and precious metals.

There are currently over 10 commodity ETFs in Europe from asset managers including BlackRock, DWS, UBS Asset Management, WisdomTree and Legal & General Investment Management (LGIM).

Inflation

These ETFs can be a hedge against inflation because the prices of commodities often rise when the value of money decreases due to inflation. This makes commodities attractive during periods of high inflation as they can retain or increase in value.

Commodity prices can have sudden swings that result from unpredictable events such as geopolitical conflicts, which makes commodity ETFs prone to volatility.

However, as these ETFs provide exposure to a broad range of commodities within a single investment, the risk associated with the volatility of individual commodities is reduced.

While there are several commodity ETFs on offer in Europe, exposure to commodities through exchange-traded products (ETPs) is usually via exchange-traded commodities (ETCs) which have structural differences from ETFs.

ETCs can track a single commodity via futures contracts or take physical ownership for exposures such as gold. Commodity ETFs, unlike ETCs, are UCITS compliant which requires them to follow minimum standards that ensure the safeguarding of investor assets.

Final word

Overall, commodity ETFs offer diversified exposure to various commodities through swaps rather than investing directly in futures contracts, providing an inflation hedge while offering the benefits of ETFs including transparency and liquidity.