LGIM lists smart-looking commodities ETF
Commodities are in a super cycle now, thanks to the Rona rebound. Commodities ETFs around the world are seeing super inflows. Seeing this and wanting a slice, LGIM is listing a commodities ETF that looks smart.
The L&G Multi-Strategy Enhanced Commodities UCITS ETF (ENCO), which will begin trading in London this week, will invest in a broad basket of commodities. These include energy, precious metals, industrial metals, agriculture and livestock. It will get access to these commodities via the Chicago commodity futures market. LGIM won’t buy the futures themselves. They’ll outsource that to an investment bank via an unfunded swap (i.e. the good kind, discussed below).
So far so familiar. But what is potentially smart (and definitely different) about ENCO is what comes next.
ENCO uses different roll strategies for each commodity. For energy commodities, the fund rolls based on seasonality, as the prices of commodities like heating oil, gas, etc. can get volatile in winter. For metals, it looks for the point in the curve with the least contango – as metals come with storage costs, meaning they’re permanently in contango. For livestock and agriculture, it looks at momentum.
In all, ENCO will likely go further out on the futures curve than other commodities ETFs, as there is less volatility and potentially less contango.
The fund charges 0.30%.
Analysis – unfunded swaps are good, but we need live performance data
There’s a lot to say about ENCO, some good, some bad. Let’s start with the good.
The fund uses unfunded swaps. This is a good thing. Some ETFs use funded swaps, which are less good. In a funded swap, an ETF’s assets are given over to the investment bank that provides the swap (i.e. the swap is “funded” from the investment bank’s perspective). This means that investors have less security if the bank defaults. In an unfunded swap model by contrast, the ETF’s assets stay in the ETF. It’s safer.
Another good thing about ENCO is the fee. 0.30% is pretty reasonable for this type of exposure, which is usually rotated by allocators (the money is less sticky) and more expensive to implement for ETF issuers.
Now onto the bad.
This roll strategy – will it outperform the ‘dumber’ old commodity ETFs? The further out on the commodity curves you go, the less volatility there is. But there is also usually less correlation to the spot price of these commodities, which is what investors want.
Meanwhile, commodities markets are some of the most sophisticated in the world. Hedge funds and the rest pour over every data point, leaving any quest for alpha on the part of ETFs an exercise in futility.
Then again, the live performance of this fund may prove this scepticism unjustified. But we’ll have to wait and see.