FTRI - GUNR: Compelling Commodities Exposure

Summary

• 2022’s geopolitical tumult saw commodity prices spike.
• Only a strong dollar and China SARS-Cov2 lockdowns provided resistance to energy upside.
• For investors interested in diversified natural resources exposure, FlexShares showcases an enticing ETF.

Macroeconomic Overview

With numerous geopolitical events rocking capital markets in 2022, calling commodity upside was not only an easy wager but also an extremely lucrative one. The Russian invasion of Ukraine early in the year forced diplomatic sanctions hampering the supply of natural resources, while Ukraine, colloquially known as the breadbasket of Europe, witnessed sizable drops in agricultural exports.

A major exporter of agricultural commodities, the ex-Soviet state, commands a significant global market share by volume in wheat (10%), barley (13%), corn (15%), and sunflower oil (50%). Any war was assuredly going to disrupt the global agricultural supply chain.

Then there was oil and gas. Russia, one of the world's largest players in the energy space, faced repercussions impacting gas exports from its Nordstream pipeline network. Cheap energy fueling Germany's exports and Europe's industrial engine has since spluttered, gas prices have spiked, and EU member states have scrambled to find alternative options.

Restrictions on insuring oil tankers shipping Ural crude were aimed at scuppering Russian energy efforts, but inadvertently created a refining opportunity for India to recycle cheap oil at a premium back to Europe. Since then, commodity prices have been in a tailspin and only China lockdowns and a super strong US dollar have quelled price upside.

Some of that has changed. The back end of 2022 saw a softening of energy prices as fears the world was on the cusp of a global recession sunk in. But what now for commodities in 2023?

China has since thrown in the towel on Draconian Covid lockdowns, and the US dollar's unwavering ascent is starting to stall. These events suggest future support for commodity prices and underscore why my outlook remains bullish.

For money managers looking to capitalize on natural resource upside, its Morningstar Global Upstream Natural Resources fund provides ample opportunity to gain exposure to a plethora of commodity plays.

Production Overview

FlexShares Trust - FlexShares Morningstar Global Upstream Natural Resources ( GUNR ) tracks an index of global commodities that operate, manage, or produce natural resources in energy, agriculture, metals, timber, or water.

Unlike more orthodox ETFs tracking a more concentrated mix of energy assets, this one provides additional diversification by covering a greater range of commodities.

The fund covers ~210 underlying securities with the lion's share part of materials (+33%), and energy (+23%) sectors. Accordingly, oil & gas, metals and mining are prominent parts of the fund's industry breakdown.

All in, the fund provides investors with risk exposure to global energy and mining, primed for upside given the above-described macro forces.

1-year total returns for GUNR (+10%) have notably outperformed the broader index (-15%)

Despite a volatile 2022, the fund has performed well over the past year (+10.85%) against the S&P 500 (-15.61%). Fund inflows suggest investor sentiment remains bullish, with $232M of cash inflows over the past month and $306M over the past year. Assets under management total $7.5B, which makes it a sizable fund in the commodity space.

Product Structure

Top holdings include Exxon Mobil Corporation ( XOM ) (+5.24%), International Holding Company PJSC ((IHC)) (+4.91%), Chevron Corporation ( CVX ) (+3.77%), and Shell plc ( SHEL ) (+3.73%). The energy sector has undoubtedly contributed meaningfully to 2022's returns.

That does not discount, however, the mining pedigree that the fund also boasts with BHP ( BHP ), Rio Tinto ( RIO ), and Glencore plc ( GLCNF ) (GLEN) making a showing in the fund prospectus.

Fund structure remains vanilla; no derivatives use, no leverage nor exotic financial constructs aimed at boosting certain fund traits. Country exposure is diversified too with the United States (+37.90%), United Kingdom (+14.49%), Canada (+13%), and Australia (+7.58%) making up part of the ETF risk profile. That gives good diversification from a country risk perspective but also exposes the package to possible political and currency headwinds.

Energy supermajors such as ( XOM ), ( CVX ) and ( SHEL ) have not only made up a substantial portfolio weighting but also delivered solid returns in 2022.

Expense ratios are competitive (+0.46%) with daily trading volumes, liquidity and spreads all being fund plus points. The ETF pays a dividend (3.99%) on a quarterly basis. In summary, the commodities-focused fund provides competitive pricing, size, and diversification worthy of any resources-focused portfolio. Options markets provide added customization for investors looking to sell calls for added income or buy long puts to protect capital gains.

Comparative analysis ( GUNR ) v ( FTRI ) v ( GNR )

Risk

Given the heavy exposure to the energy space and a drive towards sustainability, the fund is somewhat exposed to the overpoliticization of global energy. While that did nothing to hamper risk-adjusted returns for the energy sector in 2022, an outlook on energy costs, OPEC policy, and the US strategic petroleum reserve need to be factored into positioning.

The US dollar plays an important role in commodity markets, so any bullish outlook in commodity upside needs to be married to a softer outlook on the dollar. That makes sense given a pending recession and possible rate reversal during the latter part of 2023. Unlike exotic ETFs, there is little in terms of structural risk.

Key Takeaways

Geopolitical jitters in 2022 saw broad upside to commodity prices in energy, agriculture, and metals. Since then, a cooling of the global economy has provided moderation of global energy prices. Having said that, a potential reversal in dollar fortunes and a gradual re-opening of China, the world's second-biggest economy, is likely to boost demand moving into 2023.

This bodes well for investors looking to gain exposure to natural resources, and with a package like GUNR that touts competitive costs, critical size, liquidity, trading volumes, and options markets, what better way to achieve this?

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