HardAssetsInvestor

Written by Brad Zigler  |

December 03, 2009

Whither Commodity Stock Funds?

Details

Of the various ways you can invest in commodities, which did best over the past year?

• Should you have bought MOO, DBA or stock?
• How momentum is shifting
• Could futures-based funds soon overtake equity-funds?

Feline fans hate to hear the phrase, "There's more than one way to skin a cat," but investors still use it to explain the alternative routes taken to some of their portfolio exposures.

You want a commodity allocation without having to open a futures account? You could buy the stock of a commodity producer, such as Archer Daniels Midland (NYSE: ADM). Or you can cast a wider net with an investment in an industry fund, like the Market Vectors Agribusiness ETF (NYSE Arca: MOO). Alternatively, you can try an index product that holds the commodities themselves (or, rather, futures as commodity proxies), such as the PowerShares DB Agriculture Fund (NYSE Arca: DBA).

With these choices available, it's incumbent upon investors to ponder the relative merits of each instrument, so that the desired exposure can be most efficiently delivered. And while each investment's recent performance can be analyzed for clues, it ought to be remembered that the past doesn't always repeat itself. Let's look at some examples:

Buying ADM (Individual Stock)

Buying a single issue is an extremely risky move; put simply, you could end in the right neighborhood, but knocking on the wrong door. That's precisely what happened with an investment in ADM,

ADM is one of the largest components (7.5 percent) of the index tracked by MOO, although its return was swamped by other components in the portfolio. At 28.8 percent, the stock's compound annual growth rate last year was not too shabby, but it's still a rather middling track record for a MOO component, actually. And for the volatility undertaken—46.6 percent—an investment in ADM didn't offer the best risk-adjusted return.

Looking at ADM's 0.62 Sharpe ratio measures the "cost" of the stock's excess return—that is, its gain above the T-bill rate—per unit of risk. (Generally speaking and without considering other metrics, a Sharpe ratio of 1.00 represents "good" compensation for risk, and the higher the ratio, the lower the return's cost.) While not "bad" per se, ADM's performance still wasn't all that good.

Buying MOO (Agribusiness Stock ETF)

With an index-based fund, you're automatically taken to the neighborhood and forced to knock on all of its doors, therefore removing any stock-picking or management risk. The common complaint voiced by so-called active investment managers is that index-based investments are doomed to deliver only "average" (often defined as "mediocre") performance. That may be true, but as we've seen with ADM, an investor's stock-picking skills can also be subpar.

Over the past year, MOO's share value rose at 64.6 percent rate, indicating that some of the 46 companies comprising this fund's modified cap-weighted portfolio had outgunned ADM by a wide margin. Indeed, the growth rate of MOO's largest component—Potash Corp. of Saskatchewan (NYSE: POT)—was 49.7 percent last year. Even with its higher volatility, POT's risk-adjusted return was higher than ADM's.

Overall, the reward-to-risk ratio for the sector-bet MOO portfolio was higher than a wager on most of its component stocks.