Our Pick Of The Best Commodity ETFs

Instead of investing in a single, or even a handful, of companies, investment funds allow investors to diversify their money across a range – or basket – of holdings managed on their behalf.

Contributions are pooled from potentially thousands of investors and run by professionals in line with strict investment mandates, each with a particular aim. For example, a typical target might be to outperform a particular stock market return by 1% each year.

Investment funds can have exposure to an array of assets – from cash and bonds to property and shares – each fund characterised by a varying amount of risk. Read our in-depth feature on investment funds to learn more about how they work.

Exchange-traded funds, or ETFs, are a type of investment fund that provides investors with access to stock and commodities markets without requiring the share-picking skills associated with choosing individual stocks.

This is because ETFs concentrate less on individual businesses and focus more on a collection of the main investments within a particular stock or commodities market, or industrial sector.

According to Refinitiv, assets under management of ETFs listed on the London Stock Exchange (LSE) stood at £866 billion in June 2023.

You can read more here about how ETFs work. Essentially, they combine some of the characteristics of shares with some of those from index tracker funds.

Shares offer a slice of ownership of a particular company. An index tracker fund, meanwhile, is a collective investment that uses computer algorithms to help it invest in all the companies within a particular stock market index (or industrial sector) with the aim of copying its performance.

For example, a FTSE 100 ETF would aim to mimic the performance of the UK’s blue chip stock index of 100 leading company shares, whereas a mining ETF would focus on the performance of mining shares. A gold ETF would track the price of the precious metal.

With ETFs, an investment firm buys a basket of assets (shares, bonds, commodities, etc) to create a fund. It then sells shares to track the value of the fund, which is determined by the performance of the underlying assets. These shares can be traded on markets in the same way as conventional stocks.

Buying ETF shares does not mean you own a portion of the underlying assets in the way you would when buying shares directly in a company. The firm that runs the ETF owns the assets and adjusts the number of associated ETF shares to keep the price synchronised with the value of the underlying assets or index.

As with other types of shares, it is possible to apply ‘stop’, ‘limit’ and ‘open’ orders when buying ETFs. These are broker instructions that apply when certain prices are reached and are designed to head off any surprises for would-be investors.

Commodity ETFs are simply a sub-set of the wider ETF universe. Andrew Prosser, head of investments at InvestEngine, says: “Popular commodities include gold, oil, and natural gas. Commodity ETFs can track the price of either a single commodity, or a basket of commodities.”

Commodity ETFs therefore allow investors to gain exposure to commodity markets, but without high levels of investment and the other practical considerations that are usually associated with owning commodities – such as storage and insurance costs.

Commodity ETFs come in a variety of guises. So-called ‘physical’ commodity ETFs either hold the relevant asset directly, or their performance is linked to a suitable index, for example, one that tracks the price of gold.

In contrast, ‘synthetic’ or ‘swap-based’ ETFs use sophisticated financial instruments called derivatives to follow an index.

ETF providers will indicate on their product literature whether they run physical or synthetic products.

InvestEngine’s Andrew Prosser says physical and synthetic ETFs each have their pros and cons: “For example, one advantage with physically-backed ETFs is that there are no costs with storing the commodity in question.

“In comparison, synthetic funds are able to track prices of the underlying commodities more closely and have less counterparty risk. In other words, the risk of a seller not delivering the commodity.”

An exchange-traded commodity (ETC) is often described as a commodity-focused ETF. This is broadly the case but, in contrast to ETFs – which typically contain a basket of commodities or other securities – an ETC allows for exposure to one single commodity.

Broadly speaking, ETFs tend to be ‘passive’ funds, which means that they look to copy the performance of an existing index, without the need for ‘active’ asset selection. This makes them cheaper to own because they cost less to run. Generally, the less investors pay in fees, the more their money has the potential to improve returns.

As well as competitive charges, ETFs also offer investors diversification. This helps to defend against stock market shocks by spreading money across a particular sector, rather than focus on the performance of a single company. That said, with commodity ETFs, if the price of a commodity suffers across the board, investors will see the value of their holdings drop until the said commodity comes back into favour.

InvestEngine’s Andrew Prosser says: “While commodity ETFs are a far more popular way for retail investors to gain exposure to the asset class than through either direct physical exposure or through derivative contracts, the popularity of the asset class is still dwarfed by investors’ demand for exposure to more traditional asset classes, such as equity and fixed income.”

Mr Prosser adds: “On the InvestEngine platform, commodity ETFs account for less than 3% of total assets held by do-it-yourself investors, compared to 9% for fixed income ETFs and 88% for equity ETFs.”
According to Refinitiv, commodity ETF assets on the LSE stood at about £8.1 billion in June 2023, about 10% of the overall ETF market traded on the exchange.

A convenient way to access a range of ETFs is via an online investment platform. They can also be bought directly from fund providers, via a professional  financial advisor who specialises in investing, or through a robo-advisor, a half-way house between going it alone and paying for full-blown investment advice.

Before signing up to a particular platform provider, it’s worth considering a platform with the widest spread of appropriate ETF choices for your needs, ideally, at the most competitive price (see below).

Tax treatment depends on one’s individual circumstances and may be subject to future change.  The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of tax advice.

Investors buying ETFs via an online investing platform usually face two fees: an annual fund charge from the fund provider (charged as a percentage on the amount being invested), plus platform provider fees, which come in a variety of guises. These might be billed on a ‘per transaction’ basis, or linked to the size of a portfolio.

A £1,000 investment in a fund that charges 0.5% annually would cost £5.

Generally speaking, investors will also have to pay a trading fee when buying or selling ETFs. This typically works out to between £5 and £10, in addition to any annual platform fee charged by the provider concerned.

As with individual stocks and shares and other types of fund, it is possible to hold ETFs within a tax-protected product such as an individual savings account or ISA. Doing this shields the investor from paying income tax on dividends or capital gains tax on profits.