ETF: DBC – Liquidity

Commodities are hot, but difficult to invest in directly, even for sophisticated individual investors.  The ETF:  DB COMMODITY IDX TRK (AMEX:DBC) offers cost effective returns of the commodity market through an exchange traded fund from Deutsche Bank.  Details of the ETF are here or you can download the “Fund Card” here (PDF).

The fund opened on April 28, 2006.  I’ve encountered a couple of problems trading this ETF.  Most ETFs are really best when held long; usually for a period of years.  At least, theoretically.  Few ETFs have been in existence long enough to validate that strategy.  Certainly, the recent appearance of commodity and currency ETFs lack enough history to know for sure if they fit the theoretical portfolio strategy.

I manage my portfolio actively, in a hybrid value/quant style, with long-short positions.  Including commodities, which are typically weakly correlated to market returns is too attractive to pass on.  In fact, ETFs such as DBC enable advanced strategy individual investors to go a tiny bit of the way towards accessing the same tools some hedge funds employ.  Namely, investing in non-typical asset classes, like commodities.

In addition to a lack of performance data to drive the correlations and covariances of a quant strategy, there is another problem.  Many of these funds are very lightly traded.  This creates a conundrum for my strategy:  I endeavor to actively manage my quant signals by aggressively rebalancing my portfolio.  Given the volatile price movements of the commodity ETFs, I often find myself needing to take profit or accumulate DBC.

But DBC’s liquidity is very tight.  With low volumes and difficulty making the market, it is difficult to execute trades at the implied market price.  In such an environment trailing stops are dangerous and the opportunity for market gaming is large.  Unfortunately, gaming the market on something like DBC is beyond the reach of an individual investor.

Perhaps investing in a new commodity ETF is best left to a buy & pray strategy.  Gut feel is about all one can go on until these beasts either accrue a couple years worth of data or the markets become liquid.