Credit: Shutterstock photoVan Eck Global, the New York-based fund company known for its expertise in natural resources investing, filed paperwork with the Securities and Exchange Commission to market a broad-based commodity futures ETF. The ETF would be similar to a mutual fund the firm launched last week that's designed to minimize the corrosive effect contango can have on futures-related returns.
The proposed Market Vectors CM Commodity Index ETF will invest in commodity-linked derivative instruments, such as commodity index-linked notes, swap agreements, commodity futures contracts and options on futures contracts that provide exposure to the commodities in the UBS Bloomberg Constant Maturity Commodity Total Return Index. That's the same index the new Van Eck CM Commodity Index Fund uses.
The index is a rules-based benchmark diversified across 26 commodities from the following five sectors:energy, precious metals, industrial metals, agriculture and livestock. The index is comprised of futures contracts with maturities ranging from around three months to over three years for each commodity, depending on liquidity. Van Eck didn't say what the planned ETF's expense ratio would be.
Contango occurs when futures with further-out expiration dates cost more than those with nearer expiration dates. It erodes fund returns because managers have to pay up when they "roll" positions from expiring contracts to later-month ones to maintain exposure.
Much effort has gone into trying to minimize contango's effect, particularly in the world of exchange-traded products.
Competing Contango-Killing Strategies
Van Eck's planned ETF tracks the same index as the UBS E-TRACS CMCI Total Return ETN (NYSEArca:UCI). UCI is an exchange-traded note based on an index composed of 28 futures contracts with up to five maturities for each commodity. UCI has an expense ratio of 0.65 percent.
Another commodity ETP with contango in its cross-hairs is the United States Commodity Index Fund (NYSEArca:USCI). It's based on the SummerHaven Dynamic Commodity Index (SDCI), an actively oriented commodities futures index that has positions in energy, precious and industrial metals and agricultural commodities, including livestock, grains and softs. It has an expense ratio of 0.95 percent.
Summerhaven's Co-Founder and Director of Research Geert Rouwenhorst is one of the pioneers of commodities investing. Rouwenhorst, also a professor at Yale University, is perhaps best known for a paper he co-authored with Gary Gorton, Facts and Fantasies about Commodity Futures. The paper kicked off the surge of commodity investing seen in the past several years. Gorton is a senior advisor to SummerHaven.
Invesco PowerShares is another company that offers broad-based commodity products with a view to controlling contango. Its PowerShares DB Commodity Tracking ETF (NYSEArca:DBC) is the oldest broad-based commodities exchange-traded product using futures on the market. It had more than $5 billion in assets as of Friday, Jan. 7, compared to $119.7 million for USCI and $134.7 for UCI, according to data compiled by IndexUniverse.com.
PowerShares has also rolled out an ETN that offers investors the option of gaining similar exposure in an ETN wrapper. DBC's ETN counterpart, the PowerShares DB Commodity Long ETN (NYSEArca:DPU), had gathered $6.6 million as of last Friday.
ETFs Versus ETNs
ETNs like as UCI or DPU -- unlike ETFs such as the one Van Eck is planning or like DBC and USCI -- offer investors direct exposure to an underlying index, minus expenses. ETNs don't own underlying baskets of securities like ETFs do, which not only eliminates tracking error sometimes associated with ETFs, but also gives ETNs access to parts of the investment universe that are hard to cover.
The catch-and it's been a big one since the market crash of 2008/2009-is that ETNs are unsecured credit obligations backed only by the faith and good credit of their issuers.
If an issuer goes under, investors essentially forfeit their entire investment. That chance seemed very remote when ETNs first launched in 2006, though it was a real threat during the recent financial crisis. After all, three ETN backed by Lehman Brothers closed in September 2008 after the firm declared bankruptcy, and any investor who held to the bitter end lost out.
Still, some issuers say investors are getting over fears and are now curious about ETN attributes, including tax advantages.
Under prevailing IRS interpretations, commodity ETNs are taxed like zero-coupon bonds. That means investors don't owe tax on the note until they sell, the note gets called (if it's callable), or the note matures.
Investors using futures-based ETFs to gain exposure to commodities meanwhile have their positions marked-to-market each year, creating an annual tax bill. ETN investors also have to fill out 1099 tax forms, as opposed to the K1 forms reserved for investors in futures. That's true even for ETN investors with futures-based holdings.
Don't forget to check IndexUniverse.com's ETF Data section.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
