How to Avoid Getting Burned with Commodity ETFs

Before retail investors (especially degenerate zoomers) were incinerating capital on leveraged single-stock ETFs and synthetic income products flashing double-digit yields (most of which is just return of capital), older generations were losing money on commodity ETFs.

Some of that came from making the wrong directional bets during extreme periods like March 2020, when the onset of COVID-19 pushed oil prices negative and liquidated a ton of overconfident traders. But a huge portion of losses had nothing to do with timing and everything to do with picking the wrong kind of commodity ETF and getting eaten alive by structural deficiencies.

Since the last half decade has brought new innovation to the space, it is worth revisiting the common pitfalls. Three issues in particular make some commodity ETFs unpalatable in my opinion: high fees, K-1 forms, and contango.

High fees

Fees are straightforward. Even if a commodity ETF is not meant to be held long term, you still pay an expense ratio. It is calculated annually as a percentage of net asset value but deducted gradually in the background, silently reducing net returns.

Because this category is more specialized and often uses futures contracts, you should expect somewhat higher costs. But you can still be selective, as there are some absurdly priced products out there.

Costs can be reasonable if you take the time to look carefully. There are broad commodity ETFs like the SPDR Bloomberg Enhanced Roll Yield Commodity Strategy No K-1 ETF (CERY) at 0.28% or the iShares Bloomberg Roll Select Commodity Strategy ETF (CMDY) at 0.29%.

On the other hand, it can get ugly fast. The Volatility Shares 2x Wheat ETF (WHTX) and Volatility Shares 2x Corn ETF (CORX) both charge 1.85%. Even some active broad options like the PIMCO Commodity Strategy Active ETF (CMDT) come in at 1.16% (and on that note, I’m not sure why anyone would buy a commodity ETF from PIMCO, a bond specialist).

Unless you specifically want short-term trading exposure and not long-term portfolio diversification, I would avoid the overly expensive choices.

K-1 forms

I hate these things A K-1 is a tax form issued by partnerships that reports your share of income, deductions, and credits. Many commodity funds use partnership structures, which means unitholders receive a K-1 form come end-of-year tax time.

Most investors try to avoid them. The forms tend to arrive later in the tax season, which can delay your entire filing. The information they contain is more detailed than a typical 1099, so you may need extra record-keeping or professional help just to get it entered correctly.

You can also be allocated taxable income even when you didn’t sell anything, which catches newer investors off guard. Add in the possibility of multi-state reporting if the partnership earns revenue in several jurisdictions, and the whole process becomes more work than many investors want from a simple ETF position.

Some ETF issuers have recognized this pain point and now structure their products to issue simple 1099-DIV forms. These are easier to file and avoid the partnership complications entirely.

Often the fund name makes this clear, like the Invesco Optimum Yield Diversified Commodity Strategy No K-1 ETF (PDBC). Other times you need to read the prospectus or tax section carefully. Either way, K-1 issuers are an avoid for me unless there is a compelling reason to hold them.

Contango and negative roll yield

Contango is the silent killer of many commodity ETFs. It refers to a futures curve where later-dated contracts cost more than near-term ones. When an ETF holds contracts that are about to expire, it must roll into the next month. If that next contract is more expensive, the ETF sells low and buys high, locking in a negative roll yield.

A simple illustration is WTI crude. If the November contract is cheaper than the December contract, the ETF sells the cheaper November contract and buys the more expensive December contract. Repeat that again and again and you bleed performance.

This is why long-term performance for the United States Oil Fund (USO) look so horrific. USO has a -4.5% annualized return since inception and has badly lagged spot oil prices.

Some commodity ETFs avoid this by using smarter roll strategies. Instead of always rolling into the next month, they may ladder contracts, roll into less expensive parts of the curve, or avoid rolling entirely when conditions are unfavorable.

A good example is the Harbor Commodity All-Weather Strategy ETF (HGER), which has strongly outperformed most competitors. Another is the Direxion Auspice Broad Commodity Strategy ETF (COM), which can go flat in certain markets when conditions are unattractive.

Often you can identify these by names like “enhanced roll” or “commodity strategy,” but you still need to read the prospectus and check what contracts the ETF actually holds. Avoiding contango is not automatic. It is achieved through deliberate index construction or active management.