by Tom Taulli | January 28, 2011 5:00 am
Based on the media, it seems that exchange-traded fund investments or ETFs are near perfect compared with mutual funds. They are liquid, track any type of index and even allow for shorting. Yet the fact is that they are still relatively new. More importantly, there are already certain flaws that investors are encountering, such as in the commodities space. That’s where mutual funds have an edge.
Many commodity ETFs purchase futures to track an index, like the Deutsche Bank Liquid Commodity Index or the Goldman Sachs Commodity Index. However, these funds need to continually buy new futures contracts to avoid taking delivery of the commodity. That means purchases are typically at higher prices and eat into returns. In fact, it’s not uncommon for the price of a commodities index to increase and the ETF to fall!There are also adverse tax consequences that can be a nasty surprise, such as higher rates.
In light of this, it should be no surprise that investors have been pouring money into commodities mutual funds[1], not ETFs. According to Lipper Inc., 94 broad commodities mutual funds attracted $11 billion while 54 similar ETFs nabbed a measly $1 billion over the past year. The only category of ETFs that beat out mutual funds was in precious metals. Perhaps the main reason is that several of them buy the physical commodity, not the futures.
So if you’re looking to get some exposure to commodities funds, below are some options — as well as a physically backed-ETF worth buying:
Tocqueville Gold (MUTF: TGLDX[2]), which has $2.3 billion in assets, has posted a sterling average annual return of 46.96% for the past three years. With such a performance, investors are probably not too concerned about the fees. But the expense ratio is still a reasonable 1.34. It helps that the portfolio manager, John C. Hathaway, tends to take a long-term view (he has been with Tocqueville since 1997) His holdings include high quality gold — and some silver — operators like Goldcorp (NYSE: GG[3]), Toronto-listed Osisko Mining, Gold Resource Corp. (AMEX: GORO[4]) and Silver Wheaton (NYSE: SLW[5]). The fund even has 5.63% of its assets in gold bullion. But investors need to be cautious. Precious metals funds can be extremely volatile. Already this year, the Tocqueville Gold fund is off 8.47% as commodities have sustained a sell-off.
The Credit Suisse Commodity Return Strategy Fund (MUTF: CRSOX[6]), which has $4.6 billion in assets, tracks the widely-followed Dow Jones-UBS Commodity Index. This includes the futures contracts of a broad array of commodities, such as agriculture, energy, industrial metals, precious metals and livestock. To do this, the fund uses highly complex swaps, notes and other derivatives. Since these instruments require small investment amounts, the cash levels are generally high. While some funds will try to invest these balances aggressively, this has not been the case with the Credit Suisse offering. This conservative approach has certainly been helpful during stressful market environments, such as in late 2008. Unlike an ETF, this mutual fund has nearly a perfect tracking record against the index. All in all, it’s an effective way to invest in commodities that has shown relatively low levels of volatility. The fees are also only 0.70%.
RS Global Natural Resources (MUTF: RSNRX[7]) manages about $2.2 billion and has an expense ratio of 1.46%. To reduce overall volatility, the fund tends to focus on larger cap resource and mining companies. The portfolio is roughly split between industrial materials and energy companies. Some of the top holdings include Southwestern Energy Company (NYSE: SWN[8]), Martin Marietta Materials (NYSE: MLM[9]), Denbury Resources (NYSE: DNR[10]), New Gold (AMEX: NGD[11]) and Compass Minerals International (NYSE: CMP[12]). In the commodities business, another big risk is politics. It’s not uncommon for a country to nationalize a major company or for a government to collapse. Because of this, RS Global focuses primarily on companies that are based in the developed world.
When investing in commodities, some investors want to own the actual metal. This may be a way to provide a hedge against inflation or even protection if the world economy goes into a tailspin. ETFs are actually excellent vehicles for physical commodity ownership. And the ultimate is the SPDR Gold Shares (NYSE: GLD[13]). Its assets total a whopping $52.3 billion. Yes, that’s a lot of bullion bars. The gold is in vaults based in London. In fact, the fees are low, coming to 0.40%. This is certainly much better and safer than buying gold bars and storing them in your basement. There are also physical ETFs for other precious metals. These include iShares Silver Trust (NYSE: SLV[14]), ETFS Physical Platinum Shares (NYSE: PPLT[15]) and ETFS Physical Palladium Shares (NYSE: PALL[16]).
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