Commodity Exchange-Traded Funds: Observations on Risk Exposure and Performance

Abstract

This paper compares returns of ETFs holding physical commodities and ETFs holding derivative products to their respective spot commodity returns to identify significant performance differences based on the ETF assets. We regress ETF returns on spot commodity returns to estimate beta and R2 values. We use these Beta and R2 values to evaluate the relationship between the ETFs and their spot prices. We found that the physical ETFs perform more consistently with their spot commodities; these products are more likely to provide the expected risk exposure investors desire. Also this paper performs two mean comparison tests: the first compares the returns of the ETFs with their spot commodities; while the second compares the Sharpe Ratios of the ETFs with the Sharpe Ratios generated by their spot commodities. Our analysis of the Sharpe Ratios found that futures based ETFs have considerable performance divergence from the physical commodity depending on if the futures market is in backwardation or contango. Finally this paper evaluates the performance of the stack and strip methods used by WTI Crude Oil based ETFs. We found that the use of a strip method improved the performance of the WTI Crude Oil ETF when the contango in the futures market became more severe, and eroded performance as the market became flat or backwardated.