Exchange Traded Funds in the Commodities World
Exchange traded funds (ETF) are like stocks or shares and can be traded on a recognised stock exchange. For those which focus on the commodity markets they can be referred to as exchange traded commodities (ETC). Like mutual funds or unit trusts (OEICS) they are a means of spreading your investment exposure but generally they have the advantage of lower expense ratios. This is because most of them are not actually managed funds but instead they reflect or replicate a particular index in a passive way.
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In 2008 the US Securities and Exchange Commission authorised the creation of funds that can be actively managed, and the expense ratio will most likely reflect this more hands-on approach.
The ETF structure is open-ended which means units can be created or redeemed depending on the action of buyers and sellers.
Interestingly, exchange traded funds also display a characteristic of so-called closed-end funds in that during the trading day, their value can rise or fall quite significantly from the net asset value of the underlying assets.
Other benefits of ETF’s:
As an example it is possible to get exposure to a broad cross section of the commodity universe using an ETF to invest in for example, the DJ-AIGCI All Commodities Index or the Reuters Jeffries CRB Index.
The advantage of this approach is that the change in the ETF or ETC fund price reflects the return you would get from unleveraged investment in futures contracts on a spread of physical commodities which make up the particular index.
There are also ETC’s available for those who may want to invest in sub-sectors such as:
You can be even more specific and invest or trade an ETF or ETC which focuses on a particular commodity within the above sub-sectors, such as palladium, heating oil, coffee or lean hogs.
For US residents the range of ETF’s available on US stock exchanges can be traded under the investment and tax rules prevailing in that jurisdiction. Meanwhile, UK and some EU residents can invest in ETF’s and ETC’s on a number of recognised European Stock Exchanges. These include the LSE, Deutsche Bourse (Xetra), Euronext Amsterdam, Euronext Paris and Borsa Italiana. What type of funds can you invest in? Investing in straightforward commodity exposure is one option, but you can also use more sophisticated vehicles such as:
Regulation In the United States, Exchange Traded Funds which invest in commodities are not regarded as or regulated as investment companies under the Investment Company Act 1940. The legislation is evolving in this area, as the use of the exchange traded fund vehicle for commodities combines the regulatory responsibilities of both the SEC and the CFTC.
In the United Kingdom, the Financial Services Authority (under the FSMA Act 2000) has responsibility for ensuring providers of financial products comply with the legislation, and that investors are informed and protected against improper marketing and illegal activities.
The prospectus which forms the basis of the offer for ETF’s or ETC’s should comply with the relevant jurisdiction.
So, once you have considered the merits of exchange traded funds and feel that they fit your trading and investment aims, you are ready to ask for professional guidance from your financial adviser.
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