A new commodity exchange traded fund (ETF) from SummerHaven and U.S. Commodity Funds finally seems to solve an age-old problem with diversified commodity ETFs.
The U.S. Commodity Index Fund (NYSEArca: USCI) chooses from a basket of 27 eligible commodities, but only 14 are held at any given time. Most existing broad commodity ETFs hold baskets of all those commodities at once, treating them as one single asset class. Many feel that taking a passive approach to commodity investing doesn’t necessarily work.
SummerHaven partners Kurt Nelson and Yale Finance Professor and commodities expert K. Geert Rouwenhorst developed the SummerHaven Dynamic Commodity Index (SDCI) out of this belief. [How Not to Get Burned By Commodity ETFs.]
Each month, the index looks at the universe of commodities and makes its selections for what will be included that month based on price information and what’s lowest in inventory. Their methodology removes the markets that are in contango, and to further mitigate the effect, futures contracts in the fund range anywhere from three months to 12 months out. [Why Oil ETFs Are Rising.]
“We invest out along the curve and we spread our bets evenly,” says Rouwenhorst. This has the effect of diversifying the fund so that it doesn’t concentrate on any one particular commodity. Rouwenhorst and Nelson note that this is the first time a ETF has taken the leap into actively managing a basket of commodities.
Rouwenhorst believes in the revolutionary role commodity ETFs have played for retail investors, noting that they’ve helped in a couple big ways:
- Now investors can trade commodities like they trade any other stock, but at the ETF level. There are no margin requirements to be satisfied.
- Many ETFs have offered diversified commodities exposure. Doing this on your own would be very expensive and difficult to replicate. “For a small investor to maintain positions in hogs, oil, corn and wheat all at the same time, making sure that the contracts would not mature…it was a big headache,” Rouwenhorst says.
Nelson points out that commodity investing is still a relatively young business, but that many past products have not been designed with the investor in mind. That’s something they’re hoping to fix with this new product. “What we’ve taken an effort to do is to construct an index from the ground up on the principles we’re familiar with to develop an active index for investors,” says Nelson.
Each commodity’s representation in the index is capped at roughly 7% at the start of each month. The index rules also require that at least one commodity from each of the six commodity sectors: precious metals, industrial metals, energy, livestock, softs and grains.
You can view what’s currently in the index and a complete list of commodities eligible for inclusion on SummerHaven’s site. [10 New ETFs Worth a Look.]
USCI’s expense ratio is 0.95%.