Try ETFs, ETNs, Funds in Commodities

by Chuck Epstein | October 26, 2010 12:53 pm

If you are concerned about an impending bubble in bonds, and dismayed by volatility and low returns in traditional stock market sectors, consider something new: investing in agricultural commodities. 

Buttressed by bad weather and continued demand worldwide, agricultural commodities have proven to be a bright spot for many investors. Even better, this asset class benefits from a hint of rising inflation. While the average inflation rate over the past ten years has been 2.6%, when inflation does ignite, it happens quickly. Another concern: Fnancial history points out that governments have commonly solved their debt problems by hiding default in the form of higher inflation. 

The other traditional attraction of commodities is that investors can leverage the inverse price relationship that exits between stock and commodities.  This offers additional diversification opportunities to a traditional stock and bond portfolio.

Agricultural commodities were once restricted to investors who had to buy leveraged futures through futures brokers.  Not now. Today, you can choose from a number of actively-managed commodity mutual funds, ETFs and Exchange-Traded Notes (ETNs) to get a very focused exposure to a broad or sub-segment of the commodity markets (such as corn or coffee). What makes each fund, ETF or ETN different is its exposure, weighting and management strategy related to certain commodity sectors. 

To obtain the benefits of this important asset class, here are some of the top agricultural commodity funds, ETFs and ETNs to consider.

1. Oppenheimer Commodity Strategy Total Return Fund A 

Managers:        Kevin Baum (since 1999)

Robert Baker (since 2007)

Carol E. Wolf (since 2008)

Total assets: $1.5 billion

Expenses: Annual expense ratio: 1.96 (gross)

Load: 5.75%

Status: open

Minimum initial investment: $1,000

The Oppenheimer Commodity Strategy Total Return Fund (QRAAX[1]) uses qualitative and quantitative analytical methods to invest in a broad range of commodity-linked securities that invest in sectors, including energy, precious metals, industrial metals, agriculture and livestock. Since non-correlation is a selling point, the fund shows a negative 0.03 to stocks and a negative 0.17 correlation to investment-grade bonds.

The fund’s benchmark is the S&P Goldman Sachs Commodity Index and in its latest semi-annual report, the fund is down 11% (including the sales charge) for the six-month period ending June 30, 2010 versus the GSCI, down 11.21%.  Its major holdings (9.7%) are in hybrid instruments linked to commodity notes.

2. PIMCO Commodity Real Return Strategy A

Manager: Mihir Worah (since 2001)

Total assets: $18.5 billion

Expenses: 1.29% (net)

Load: 5.50%

Status: open

Minimum initial investment: $1,000

As you would expect, the PIMCO Commodity Real Return Strategy (PCRAX[2]) fund uses a hybrid strategy. Unlike other funds which invest in physical commodities, the Fund buys index-linked derivatives which help it diversify without committing substantial capital.

The fund then “collateralizes” these derivatives with an actively managed TIPS portfolio. This dual approach seeks to capitalize on real (after-inflation) returns from commodities and real returns from TIPS. The fund is benchmarked to the Dow Jones–UBS Commodity Total Return Index.

As of Sept. 30, 2010, the fund posted a return of 7% compared to its benchmark’s return of 0.9%.

3. Goldman Sachs Commodity Strategy Fund A

Manager: Steve Lucas and Michael Johnson (since 2007)

Total assets: $710 million

Expenses: 1.17% (net)

Load: 4.5%

Status: Open

Minimum initial investment:  $1,000

The Goldman Sachs Commodity Strategy Fund A (GSCAX[3]) seeks a long-term total return from its returns in commodity-linked notes that offer access to returns of the S&P GSCI Commodity Index. Its portfolio of commodity index-linked securities (including leveraged and unleveraged structured notes) and derivative instruments provide exposure to the performance of the commodities markets, and in other fixed income and debt instruments. 

Unlike other funds, its return comes from an indirect exposure to commodities via financial instruments, such as foreign and domestic bonds, which are linked to commodity indexes, including leveraged and unleveraged structure notes.

 Its one-year return (pre-expense) was 4.41%.

4. Exchange-Traded Funds (ETFs)

Competition in the ETF sector is becoming more intense as an increasing number of ETNs (exchange-traded notes) come into the market.  As the next screen shows, ETNs offer the same commodity exposure, including some which are even more focused, say specifically on coffee.   

Still, ETFs remain popular. Here are some of the top commodity ETFs now trading:

Market Vectors Global Agribusiness ETFs (NYSE: MOO[4]) invests at least 80% of its assets in equity securities of U.S. and foreign companies primarily engaged in the agriculture business, which derive at least 50% of their total revenues from agribusiness. Its major holdings include Deere (NYSE: DE[5]), Mosaic (NYSE: MOS[6]), Monsanto (NYSE: MON[7]), Potash Corp. (NYSE: POT[8]) and Syngenta (NYSE: SYT[9]). This ETF tracks the DAXglobal Agribusiness Index.

PowerShares DB Agriculture ETFs (DBA) is based on the Deutsche Bank Liquid Commodity Index – Optimum Yield Agriculture Excess Return. The index is a rules-based index composed of futures contracts on some of the most liquid and widely traded agricultural commodity futures contracts including coffee, corn, wheat, soybeans and sugar.

5. Exchange-Traded Notes (ETNs)

ETNs have an ominous-sounding definition of being senior, unsecured, unsubordinated debt security issued by an underwriting bank. They are categorized as “structured products,” but in reality, they are like ETFs is many respects and can be bought and sold in advancing and declining markets and are linked to a benchmark (an index or a sub-index).  The bank underwrites the note and agrees to pay a return based on an index’s performance, less a fee, at the time of maturity. 

One difference is that since an ETN is issued by a bank, the investor has a risk associated with the bank’s ratings and credit quality.  Another difference is that unlike a mutual fund, the ETN does not own anything except its exposure to the underlying index. Some big attractions are that ETNs have no tracking error and are very tax-efficient.

Here are four top-rated ETNs (based on returns) which posted an average return of about 26% over the past year:

IPATH Dow-Jones-UBS Coffee Subindex Total Return ETN (NYSE: JO[10]), up 33.2% over the past year, is a very caffeinated play which is 100% coffee. It is benchmarked to the Dow Jones-UBS Coffee Total Return Sub-Index.          
Elements Rogers International Commodity Index-Agriculture Total Return ETN (NYSE: RJA[11]) posted a 25% gain over the last year.  It tracks the Rogers International Commodity Index – Agriculture Total Return, a 21-component index.            
IPath Dow-Jones-UBS Agriculture Total Return Sub-Index ETN (NYSE: JJA[12]), up 23%, is composed of seven agricultural futures contracts (coffee, cotton, sugar, wheat, soybeans, soybean oil, corn) traded on U.S. exchanges.            
IPath Dow-Jones-UBS Grains Subindex Total Return ETN (NYSE: JJG[13]), up 22%, is a pure-play on three grain futures contracts (soybeans, wheat, corn) traded on U.S. futures exchanges.              
  1. QRAAX:
  2. PCRAX:
  3. GSCAX:
  4. MOO:
  5. DE:
  6. MOS:
  7. MON:
  8. POT:
  9. SYT:
  10. JO:
  11. RJA:
  12. JJA:
  13. JJG:

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