A commodity fund opens door to new investment options

Feb 13, 2006 @ 12:01 am

By David Hoffman

NEW YORK - A new exchange-traded commodities pool has opened the floodgates to a new universe of ETF products, according to industry experts.

The DB Commodity Index Tracking Fund, launched Feb. 3 and advised by New York-based DB Commodity Services LLC, resembles traditional exchange traded funds in every way except that instead of investing in stocks or bonds, it uses futures contracts to get direct exposure to the commodities marketplace.

That's something financial advisers said they have been seeking for some time.

But the fund, which is offered by a unit of Frankfurt, Germany-based Deutsche Bank AG, has importance beyond the commodities markets, said Jim Wiandt, president of Index Publications LLC in New York and publisher of the Journal of Indexes and the Exchange-Traded Funds Report.

"I think it's hard to overstate the magnitude of this development for the ETF industry," he said. "I've been around the industry for a long time, and I think there is a palpable sense of the doors' having been blown open with this structure, even more so than they would be with implementation of an active structure ... just because this allows things to happen in terms of equities that are niche and have never been possible before."

That's because futures contracts can be used to "equitize" almost anything, Mr. Wiandt said.

At first, investors will likely see other commodities funds that are in registration, he said.

For example, Barclays Global Investors of San Francisco has an exchange-traded commodities fund in registration that would track the Goldman Sachs Commodity Index. And Victoria Bay Asset Management LLC of Alameda, Calif., is planning the United States Oil Fund LP, an exchange-traded limited partnership that plans to use futures to invest in oil.

But eventually, investors could see such investments as exchange-traded products that trade on macroeconomic indicators such as the gross domestic product or inflation, Mr. Wiandt said.

And if the Securities and Exchange Commission can get comfortable with giving the green light to an exchange-traded structure that uses futures, then leveraged or inverse exchange-traded products - such as the ones ProFund Advisors LLC of Bethesda, Md., has had in registration for more than five years - can't be far behind, Mr. Wiandt said.

Other industry experts, however, feel that such funds may still be a ways off.

There is no doubt the Deutsche fund "is another step forward" in the evolution of exchange-traded products, but it does not mean that the SEC has gotten comfortable with the use of such tactics as leverage in exchange-traded products, said Herb Blank, president of QED International Associates Inc. of New York, an industry consulting firm.

It signals only that the SEC is comfortable with a product that uses futures to track the somewhat diversified DB Commodities Index, he said.

That in itself, however, is big news for financial advisers.

Advisers said they are excited, because it's the first product to give them direct access to a market they have been craving: the broad commodities market.

Two popular exchange-traded gold funds were recently launched - the streetTRACKS Gold Shares Fund from State Street Global Advisors Inc. of Boston and the iShares COMEX Gold Trust from Barclays. But neither of those funds uses futures to access the broader commodities markets.

"I think it's an excellent idea," said Lewis Altfest, president of L.J. Altfest & Co. Inc. in New York.

Commodities are uncorrelated to stocks or bonds and can be an excellent way to provide diversification, he said.

It's such a good idea that Mr. Altfest, who doesn't currently use ETFs, said he would have to take a close look at the new fund.

Considering how well commodities have performed over the last few years, "a strong argument" can be made that it makes sense to have at least a small amount of a client's portfolio in commodities, said Thomas F. "Tif" Joyce, president of Joyce Financial Management in Sebastopol, Calif.

The new Deutsche fund may be a good way to get that exposure, he said.

There are currently a handful of mutual funds that provide investors indirect access to the commodities market, notably the $12 billion Pimco Commodity Real Return Strategy Fund, advised by Allianz Global Fund Management LLC of New York.

Total-return swaps

The Pimco fund provides access to the commodities market by using total-return swaps, in which the fund will pay the London interbank offered rate plus a few hundredths of a percentage point in exchange for the total return of an index.

The problem with that approach, however, is that its mere existence was thrown into jeopardy thanks to an Internal Revenue Service ruling late last year.

That ruling said that gains from swaps are not considered qualifying income. Unfortunately, 90% of a fund's income must be qualified to make it a registered investment company. If a fund loses that status, it is subject to taxation of its income at both the fund level and again when the income flows to individual investors - not a good deal for investors.

The Pimco fund is trying to figure out how best to approach the issue.

But because the Deutsche fund is a commodity pool that uses futures, it's not surrounded by the same uncertainty, said Kevin Rich, chief executive of DB Commodity Services.

"The taxes will be consistent with [those on] other commodities investments," he said.

Unfortunately, that means that the fund won't be as tax efficient as more traditional exchange traded funds that invest in stocks or bonds.

It's a fact that may makes it suitable only for tax-exempt accounts, said Mr. Joyce.

Even that, however, isn't enough to dampen adviser interest in the product.

"It really is kind of opening up a whole new world of opportunities," said Tom Lydon, president of Global Trends Investments, a financial advisory firm in Newport Beach, Calif.

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