COM ETF: A Low Volatility Play On Commodities (NYSEARCA:COM)

Thesis

Direxion Auspice Broad Commodity Strategy ETF (NYSEARCA:COM) is a commodities focused exchange traded fund. The vehicle invests in a basket of 12 commodities futures contracts, via a rules based approach:

The Auspice Broad Commodity Index (ABCERI) is a rules-based long/flat broad commodity index that seeks to capture the majority of the commodity upside returns, while seeking to mitigate downside risk. The Index is made up of a diversified portfolio of 12 commodities futures contracts (Silver, Gold, Copper, Heating Oil, Natural Gas, Gasoline, Crude Oil, Wheat, Soybeans, Corn, Cotton, and Sugar) that based on price trends can individually be Long or Flat (in Cash).

The fund has the aim to outperform the Auspice Broad Commodity Index, and unlike other commodities funds which take pure long positions in futures with different weightings, COM actually tries to reduce its volatility and positioning when certain proprietary signals flash a bear market in the underlying risk factor. To that end, the fund has the following positioning:

The vehicle is currently very light on exposures, with long positions in gold, silver, soybeans and heating oil only. This active rules based approach has helped the name keep its annualized volatility very low when compared to its peers. We are going to have a closer look at the fund’s analytics and compare it to its peers in a section below.

We like this approach for the commodities asset class, where quant signals can be used to temporarily exit certain risk factors. Commodities can have very violent drawdowns, best seen in the natural gas space, a commodity which is down over -37% since its high in October 2023. COM is currently flat on the natural gas risk factor.

A cyclical asset class, but a portfolio diversifier

Commodities represent a cyclical asset class, but they can diversify a portfolio, especially when cyclicality is taken into account. Cyclicality refers to the propensity of commodities to rally hard during certain time-frames, while in significant down-turns during recessionary or pre-recessionary times. They are an asset class that is best traded, rather than representing a ‘buy-and-hold’ investment.

By ‘trading’ commodities we do not mean the daily active trading of commodity futures, but the addition and subtraction of a broad based commodities fund like COM during overall market cycles. As a rule of thumb, a retail investor should buy commodities and COM when they are completely out of favor, and sell them when everybody is chasing them:

We are again entering a phase where the investor community is severely underweight commodities. The easiest explanation here is that despite the ‘soft landing‘ consensus, many investors fear a mild recession. Any form of recession will decrease the demand side for commodities, hence the underweight exposure. While the stock market has been helped by the AI revolution and the large cap mega-techs, there is no such ‘savior’ in the commodities space.

Nobody can time the market, and we are certainly not ones who claim we can, but such pessimism around this asset class signals a good entry point. A retail investor can choose to drip small amounts into COM every week for a period of time to ensure the entry point is averaged out.

COM is a low volatility instrument

COM achieves the rare feat of low volatility in the commodities space. The fund does this by eliminating exposures to individual commodities that trigger a proprietary sell signal. The fund proceeds to exit the respective risk factor and just sits in T-bills. By taking an active approach to its underlying risk factors, COM is able to achieve an enviable annual volatility and standard deviation:

You can access the above data via the ‘Risk’ tab present on the Seeking Alpha platform. This tab is present for the universe of ETFs out there and represents a very useful tool in quantifying the riskiness of a potential investment. As we can see from the above table, COM has the lowest volatility from the cohort, but more importantly its volatility is half of the one exhibited by the other instruments. We can see this outstanding historic performance when benchmarking the index the ETF is following versus competing market commodity indices:

If we look at the ABCERI performance, we can see shallow drawdowns and low annualized standard deviations when compared to the competition. As an example, the S&P GSC index exhibits an astounding -79% maximum drawdown. As a rule of thumb, a retail investor should never go long instruments with drawdowns above -50%. Few people resist such stomach churning drawdown profiles. Just imagine being down -79% on your investment. Would you still hold it?

Performance

What is outstanding about COM and its rules based approach is the propensity of the fund to navigate very well down cycles in commodities:

If we look at the above total return table, we will notice the propensity of the ETF to be close to flat during down years, and up substantially during commodity up-cycles. The fund was flat in 2018 and 2019, with a small positive performance in 2020. The vehicle produced spectacular results in 2021, followed by a good 2022. Last year the fund was modestly down, helped by the high interest rate environment that offset via the carry some of the losses on the underlying risk factors.

At the end of the day, a retail investor needs to look at the above table and understand that even during down years the fund is very modestly down as compared to its peers:

The same series for the Invesco DB Commodity Index Tracking Fund ETF (DBC) looks quite different. DBC was down significantly in 2018, loss which was recouped in 2019. The fund also posted higher figures during the 2021/2022 up-cycle.

The second take-away from the COM historic performance is its propensity to outperform its benchmark index. This is mainly due to the high interest rates realized on cash holdings currently, risk-free rates which are not factored in the underlying index performance.

Conclusion

COM is an exchange traded fund that offers investors exposure to the commodities asset class via futures. The vehicle is unique in terms of taking a rules based approach towards a basket of 12 commodity futures, with the fund exiting positions when quant signals turn negative. As an example, the ETF is long only 4 commodities currently out of the entire basket, with the rest of the funds sitting in cash. This rules based approach has helped COM navigate the market with a very low annualized volatility of 7.16%, and a yearly return profile which shows quasi-flat performances during down years as opposed to other competing funds. We like COM here in a world where all investment managers are negative on the asset class, and we feel its rules based approach ensures low drawdowns during down-cycles while capturing a significant portion of the upside during market rallies.