Are These New ETFs a Good Idea?

By Dan Culloton –
StreetTracks Gold Shares (GLD) , the first exchange-traded fund tracking a commodity, was one of the most successful ETF launches in history. Within weeks of its November 2004 launch it amassed more than $1.5 billion in assets. Is it any wonder that other financial firms are scrambling to introduce their own commodity ETFs?
In fact, ETF purveyors are much like traditional mutual fund companies in that they aren’t above launching new funds in asset classes that have enjoyed strong recent performance and have gotten a lot of attention.

Not all of the new commodity ETF proposals, which include offerings tracking silver, oil, and the euro, are without merit. In many cases, however, they sacrifice the tax efficiency and transparency of stock ETFs and should be approached with caution.
It’ll be a while before these proposed funds see their first trade. (It took the Securities and Exchange Commission nearly two years to approve the first gold ETF.) Nevertheless, here’s an early line on some notable new ideas.
Silver Warning Bells
Barclays Global Investors, which was second to market with its gold ETF (iShares Comex Gold Trust (IAU) ), is first in line with a fund that tracks the price of silver. Like the gold ETFs, iShares Silver Trust will hold the actual metal in an account with JP Morgan Chase’s London branch. It will allow small investors to share the costs and hassles of owning silver directly (i.e. storage, assaying, and insurance expenses) with other shareholders and will charge a 0.50% management fee, according to SEC filings.
The silver ETF, however, is like its gold counterparts in other, less appealing ways. It will sell silver to pay its expenses, so the amount of the metal represented by the ETF’s shares will decline over time. If the price of silver doesn’t rise enough to compensate for those sales, the share price will decline. Those silver sales, by the way, will be a big taxable event for U.S. investors. Under current tax law, long-term capital gains on silver are taxed at the maximum rate of 28% because silver is considered a collectible.
The fund will be able to hurt you in other ways, too. One can make an argument for owning gold as an inflation hedge, but it’s harder to make a case for silver, which is notoriously volatile. The metal’s price fell for seven straight years after 1985. Increased demand from industrial users, as well as investors looking for an alternative to crummy stock market returns over the last five years, has helped propel silver prices from less than $3 per ounce to nearly $7 recently. The best time to discover this metal’s virtues as a portfolio diversifier was when it was still in the doldrums, not now when it is coming off a rally. Most investors are better off dodging this silver bullet.
Strange Currencies
Rydex Investments thinks investors should be able use an ETF to speculate on the price of the euro or to hedge the foreign currency exposure. The proposed Rydex Euro Currency Trust will track the price of the European Union’s currency versus the dollar. This fund, which will trade on the New York Stock Exchange, could make another market that has been the province of large investors accessible to small fries.
The ETF, however, has many of the same drawbacks as the metals funds. It will tap interest earned on the euros it buys to pay expenses, but if that income isn’t sufficient it will have to sell euros. Those sales could erode the ETF’s share price if the currency doesn’t appreciate enough and would be taxable events for U.S. shareholders.
This fund’s biggest bugaboo, however, is the unpredictable nature of foreign exchange rates. Even Federal Reserve Chairman Alan Greenspan has likened any attempts to predict the course of currencies to a coin toss. Heck, you just have to look at this year: At its onset, everyone was convinced that the dollar would continue to struggle against the euro, but in fact the opposite has been true so far. And as for currency hedging, most studies show that over the long term it has minimal effect on returns. Small investors would probably do more harm to themselves than good with this fund.
Oil ETF Gusher
A couple of small firms have decided that now is a good time to introduce oil ETFs. We’re wary of these, though, and not just because they were conceived as energy prices hit record highs. Macro Securities Depositor LLC of Morristown, N.J. wants to offer two ETFs that would use derivatives to track the price of Brent crude oil. One will allow investors to bet that the price of Brent crude is going up and the other will let them wager it is going down. Such calls are difficult, if not impossible, to get right consistently over the long term with broad stock and bond-market funds and much more so with narrowly focused portfolios, such as one that focuses on oil.
Alameda, Calif.-based Ameristock Funds’ New York Oil ETF will try to track the price of light, sweet crude oil by investing in oil futures contracts on the New York Mercantile Exchange. It will charge a fairly reasonable management fee of 0.4% on the first $1 billion in assets and 0.2% thereafter, according to the prospectus.
Manager Nicholas D. Gerber, longtime manager of the Ameristock Fund (AMSTX) , has no experience running a commodity pool, though. Gerber also has a history of floating trial balloons that sink. For example, he liquidated his Ameristock Focused Value Fund after a scheme to convert it into a publicly traded holding company flopped. It’s hard to get too excited about either of these offerings.
The Basket Approach
Deutsche Bank’s proposed DB Commodity Index Tracking Fund is a little more promising. Rather than focusing on one particular commodity, it will use futures to track an index of them: The Deutsche Bank Liquid Commodity Index. The benchmark includes crude oil, heating oil, aluminum, gold, corn, and wheat. That offers investors more diversified commodities exposure in one package.
Still, it’s not as diversified as at least one other traditional mutual fund option. The Deutsche ETF would devote more than half its assets to crude and heating oil. PIMCO Commodity Real Return (PCRIX) , however, caps energy exposure at a third of assets. Deutsche’s index also has no history, so it’s anybody’s guess how it will behave.
Furthermore, unlike most ETFs it’s hard to figure out what you would pay for this fund. The offering estimates total costs (including management fee, operating expenses, and sales charges) of 4.9% for investors who buy it during its initial offering (during which it plans to charge a 3% load) and of 1.9% for those who buy it in the secondary market. The portfolio expects to earn interest income that can be used to offset much or all of those expenses, depending on how you buy it and the performance of the fund. That’s not the level of fee transparency to which ETF investors are accustomed, though.
Source: Forbes

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