Commodity Asset Class in Dividend Growth Portfolio

One of basic tenets of portfolio construction is following the principles of asset allocation. This is much more applicable and valid for do-it-yourself individual investors. In this context, at a minimum, I need to look at and at least consider evaluating all possible asset classes. While doing this, I also have to keep in mind that my portfolio is based on dividend growth philosophy. Among others, a commodity is also one asset class which I believe I should be investing. The next question is what should be my investing vehicle.

Since 2001, quite a few commodity index based Exchange Trade Funds (ETF) and Exchange Traded Notes (ETN) were introduced in the market. There are more than 30 commodity ETFs/ETNs of various flavors based on agriculture, raw metals, coal, water, oil, natural gas, gold, silver, different combinations of these in index format, etc. And how can we forget, the biggest sham of all investment vehicles, futures-based index ETFs/ETNs. My viewpoint is, futures-based index are just designed for speculation. As it always happens, during the speculative boom of late 2007 and early 2008, every month a commodity ETF or ETN was launched in market in one form or other.

As an individual investor I need to understand how these different forms of investment vehicles fit into my portfolio, what my expectation is, and what is my objective for investment in them. Not all commodity ETFs and ETNs are created equal. And as with any other investment vehicle, what is the price I am willing to pay.

In general, across many index-based ETF/ETN, I find that almost 25% to 30% of weight is occupied by usual suspects of 10 to 15 companies. At the height of commodity boom between late 2007 and mid 2008, MON, POT, BHP, RIO, RTP, SLB, and few big oil companies were in almost every other ETF/ETN. Being a dividend growth investor, when I look at this menu of ETF and ETN choices, I do not find a single investment as a worthy investment. In their current form and constituents, these commodity ETFs/ETNs do not meet my objectives and hence have no role to play in my portfolio. Perhaps they will never be unless there is any change in construction of these ETF/ETNs.

However, I do want to own commodity as an asset class. So I like to invest in corporations that do business in commodity extraction, processing, marketing, etc. These are very good proxy for investing in commodity asset class. There are quite a few corporations that have profitable business models in almost all types of commodity business. One of the characteristics of almost all commodity businesses is that it is a very cyclical in nature. I believe that’s where the opportunity lies for dividend growth investor. Knowing that business is cyclic, we need to look for corporations that manage it around this constraint. Consistency and/or growth in dividends is a perfect measure for this aspect.

I am currently invested in BP (for oil), NUE (for steel), and DBN (materials).

In addition, following is the shortlist that I am watching and studying for my dividend growth portfolio.

  • Chemicals (DD, DOW, PX, IFF, ARJ, TNH);
  • Agriculture (ADM, MON, BG, AGU);
  • Oil (SLB, XOM, CVX);
  • Coal (ACI);
  • Iron ore (BBL);
  • Steel/Iron (GNI, RTP); and
  • Gold (RGLD).

While it is true that not all pay consistently growing dividends, but that’s the case in all sectors. As a dividend growth investor, I need to pick those that I think best suits my portfolio objective.

What this shows is there are so many corporations in commodity business, that dividend investors can easily avoid ETFs/ETNs. Investing in good quality individual corporations are very good proxy for commodity asset class.

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