Should You Be Weary of Inverse Commodity ETFs? via Attain Capital

Last week, we touched on potential markets that might finally be breaking out of the slow moving commodities sell off that’s been going on for around a year. In that post, we do what we do every month, looking at the difference in performance between the commodity futures market (Dec. contract) to its commodity ETF counterpart. This time around, we got to thinking it might be interesting to look at the flipside of that…. How inverse ETFs have performed against those same futures markets.

Here’s what we found:

Inverser ETF Table Inverse Commodity ETFs
Inverse Commodity ETFs

At first thought, you might think that the ETFs are outperforming the futures counterparts until you realize that those inverse ETFs should all be positive due to the fact that the futures contract they supposedly track are negative. So, technically, if you shorted the December 2015 futures market at the beginning of the year you would have made 22.57% while the 3x inverse Crude ETN DWTI is down -13.34% YTD. The same can be said about natural gas, but to a lesser extent; the inverse ETF up 5% while the futures contract is down -21.02% (Disclaimer: Past performance is not necessarily indicative of future results).

Part of the reason for the major disparity in returns is because most of these ETFs follow the front month contracts while the ETF prices are affected by the role in contract each month. Here’s etf.com’s description of the inverse crude ETF DWTI.

“Since DWTI tracks an excess return version of the S&P GSCI Crude Oil Index, returns will reflect both the changes in the price of WTI crude oil and any returns from rolling futures contracts.”

Be careful though to go off of 10 month or even 12 month returns (Ben Carlson on A Wealth of Common Sense has a great post on this), because as an investor, if  you would have  picked the absolute perfect time to get out of the market (Aug. 24th) you would have been up 97.88%, while the futures contract would have been down -33.31% (you would be up that percentage if shorting).

DWTI 1 One Chart  Inverse Commodity ETFs
Inverse Commodity ETFs

(Disclaimer: Past performance is not necessarily indicative of future results)
Chart Courtesy: Barchart

Our point: Unless you’re making a career out of trading these markets, trying to time when to enter and exit a commodity market is dangerous and can be costly. Case in point, the first sentence of the DWTI ETF…

Like most geared inverse products, DWTI is designed to be used as a tactical trading tool, not as a buy-and-hold investment.

But that doesn’t mean that you shouldn’t have access to strategies that allow you to reap the gains. If you haven’t guessed what’s coming next, we’re about to name drop Managed Futures. These strategies are built to seek return drivers off of rising and falling markets. This is how the industry did as a whole during crude’s collapse.

Managed Futures vs Newedge  Inverse Commodity ETFs
Inverse Commodity ETFs

(Disclaimer: Past performance is not necessarily indicative of future results)
Source: Newedge
Data through Jan 12th, 2015

Our firm is dedicated to searching through the managed futures space in order to find the best strategies out there. Some managers will tell you where they think commodities are going; some will tell you they let the algorithms do the talking. In our experience, we like to know that they have a feel for the market but at the end of the day they leave the emotions out of the decision making.  Ultimately, we, nor they, can tell you where commodities are going, but that’s the beauty of Managed Futures strategies; they don’t know, but it doesn’t matter if prices fall or rise, it’s more about capturing the trend as it continues to fall of rise.

P.S. – To understand where Alternative Investment return drivers come from, download our whitepaper, “The Truth and Lies in Alternative Investments.