A Look Under the Hood of an ETF

John Koch, CFA - Senior Investment Analyst |

The name of an ETF doesn’t tell you much about it. An advisor needs to dig under the hood to truly know the type of exposure they are getting when they invest. An investment like the SPDR S&P Global Natural Resources ETF (GNR) takes time and effort to understand it truly. Global could mean many different countries, developed or emerging markets. Natural resources could refer to many other resources, such as metals, mining, agriculture, energy, etc. But how is access to those natural resources obtained? Natural resource equities, owning the underlying asset itself, or perhaps futures contracts? Does investing in GNR give access to a truly diversifying alternative investment? Or is it just another way to gain equity exposure that will generally move in the same direction and magnitude as the S&P 500? Many of these questions may enter an advisor’s mind when analyzing a potential ETF for inclusion into a diversified portfolio.

It is always important to read the prospectus of any ETF you consider investing in. That will answer many of the questions posed in the earlier paragraph. However, if one were to invest in GNR based on its name and Morningstar category (Natural Resources), it would be easy to think that this ETF could be seen as a replacement for broad commodity exposure. But, because GNR is a pure equity investment, with 31 out of its 100 holdings also appearing in the S&P 500, there may be more underlying equity risk involved with GNR than one might expect purely based on its name and category. That is not to say GNR is a lousy investment; it provides valuable exposure to the leading natural resources companies worldwide, most of which will not be found in most traditional investment portfolios. Over time, though, GNR will be more likely to move in the same direction as the other investments in the equity part of a portfolio. If looking for truly diversified exposure in such areas, it might be wise to pair GNR with a broad commodity index-based ETF that owns futures contracts of actual commodities that will have a distinctively different return profile than the other investments within a traditional stock/bond portfolio.

An example of this relationship can be seen in the image below. Over the last three years, the return profile of GNR has matched that of the S&P 500 much more closely (the light blue and dark blue lines) than the S&P Goldman Sachs Commodity Index (red line), which is an index that tracks the price changes of a basket of broad commodities.

This post is not meant to “pick on” GNR. It has been presented as an example of advisors needing to look under the proverbial hood before investing in ETFs that might be assumed to have a particular exposure. There are also free online tools and databases advisors could use to analyze an ETF's complete underlying holdings and how this may affect an entire investment portfolio.

If you are interested in learning about more of these online tools or would like to discuss the benefits of fully outsourcing your investment management to a firm like iSectors, please do not hesitate to contact us today.