When looking to commodities, consider long/short funds, ETFs

The case for investing in commodities is clear: They usually don't correlate strongly with stocks and bonds, and if you invest in a basket of them, the returns can be more consistent than those of stocks. “Over last 10 years, commodities have outperformed equities with lower volatility,” said John Catizone, managing director and head of commodities sales in the Americas for BNP Paribas. Mr. Catizone was part of panel at Pershing LLC's Insite 2012 conference addressing the best ways to get investment exposure to commodities. However, finding the right investment vehicle to capture those returns has been a challenge. “The biggest problem in the sector over the last couple of years has been the experience with returns,” said Ryan Harder, a portfolio manager at Guggenheim Investments who specializes in managed-futures strategies. “While the price of oil doubled over the last several years, gasoline and crude-oil ETFs did nothing.” The reason for that has been the behavior of the futures markets. Because many of the energy futures markets — which most mutual funds and exchange-traded funds use to build exposure to commodities assets, have been in so-called contango during much of the last few years, their returns have been much lower than the simple price movements in the underlying commodities. The contango phenomenon refers to the market condition where the futures contract price of a commodity is higher than the expected spot price at that future date. The futures price converges toward the spot price as the contract nears maturity. The opposite condition — where the futures price is lower than the spot price, is called backwardation. Confusing, yes. But the upshot is that investors in futures contracts that are substantially in contango can lose more money rolling over their contracts than they make from a rise in prices of the underlying asset. This happened with many of the ETFs with long-only investing strategies in energy markets. “It can be incredibly frustrating when you make the right call but have nothing to show for it,” Mr. Harder said. One solution is to invest in long/short or market-neutral funds that can buy or sell commodities based both on fundamentals and on conditions in the futures markets. Another option is a new product that actively assesses the futures markets and determine the best place to invest on the futures curve. “The dynamic-roll ETF looks at the shape of the futures curve in determining where to allocate to commodities,” said Mr. Catizone, whose firm recently introduced such a vehicle — the Stream S&P Dynamic Roll Global Commodities Fund. “You've got to be aware of what you're investing in and what it does under different market conditions,” he said.