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ETF Strategist: Getting Your Arms Around Commodities

As the universe of exchange traded funds grows larger and ever more diverse, more retail investors are gravitating to the financial instrument.

The choices for investors looking for diversity are almost limitless. Nothing illustrates that better than commodities-based ETFs, or ETNs, their first cousin. About 25 percent of the 1,400 funds out there have something to do with commodities, covering everything from metalsto energyto agriculture.

Now a trillion-dollar business, ETFs are still nowhere near the size of the rival mutual fundindustry, but their liquidity — they trade throughout the day like stocks — makes them more of a stock- marketforce than their number suggests.

ETF Strategist
ETF Strategist

In today's high-speed trading environment, ETFs can be bought and sold over and over during the trading day — not like mutual funds, which are priced once a day, and after the close of trading. Critics say this has contributed to increased volatility and the short-term trading mentality (which was associated with the so-called "Flash Crash"of 2010), but at the very least, such liquidity puts retail investors on an equal footing with larger ones.

ETFs are also attractive because of their low cost (trading fees) and favorable tax exposure — in most cases taxable income can be deferred, while some funds don't have capital gains distributions or pay dividends.

It's worth noting, however, that all ETFs are not created equal. Some are unusually narrow in focus, the antithesis of diversification. Others are leveraged, based not on actual securities and/or indices but derivatives based on an underlying index, and seek to outperform, not mirror what they track.

The verdict on ETFs is still out. Not even 20 years old, the industry's track record is not a long one; many EFTs are not much more than 5 years old.

Our special report,"ETF Strategist," gives investors a better understanding of the wide world of ETFs, providing the pros and cons of investing in various asset classes and sectors (and related portfolios) that offer diversification.

Having already tackled fixed-income, we're on to commodities in March. Look for more editions each month through June.

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