Elkhorn Fundamental Commodity Strategy
The global commodity markets are in year seven of a massive bear market; some have even called it a commodity depression. But commodity markets tend to move in waves, spending years with small returns only to suddenly surge higher as they enter a new supercycle.
RCOM is the fund for investors who want to be well-positioned when that next supercycle appears. Leveraging cutting-edge research from research affiliates—and a nifty structure that helps it avoid issuing a k-1—it’s a version 2.0 commodity product that is a perfect fit for today’s markets.
Right now, not many investors are thinking about commodities, but with global growth picking up, that could change in a heartbeat. RCOM is a product for that moment.
Matt Hougan, CEO, Inside ETFs: Why did you develop RCOM?
Ben Fulton, Founder and CEO, Elkhorn: A little over a decade ago, I had the pleasure of working with Deutsche Bank to create the first series of commodity ETFs. At that time, we looked long and hard at all the commodity indexes out there. The index we settled on had some nice advantages: It wasn’t production weighted and therefore overweight oil like the S&P GSCI; it wasn’t equal weighted like the CCI; and it took into consideration the roll curve of commodities, which helped its performance. But while it was a good index, I’m not sure it’s a great index.
A decade later, I was sitting through a presentation with Research Affiliates about commodities. I wondered what their take would be coming into the meeting, because Research Affiliates is known for “fundamental weighting” and you can’t really fundamentally weight commodities.
But they took a very analytical approach to figuring out the best way to build a great commodity index. They identified and isolated certain things that worked in commodities, including momentum, roll yield and more. It struck me as a really great index. So I asked them if I could bring an ETF to market based on their index.
We are in the middle of a commodity depression. At some point, we’re going to come out of it. People are going to want a better index when we do. The Research Affiliates Index … and RCOM … is it.
What’s different about RCOM’s index versus other indexes?
Research Affiliates looked at three key factors when figuring out how to build the index: liquidity, momentum and implied roll yield. Liquidity is almost a proxy for production, and it helps ensure the strategy is representative of the commodity space and has high investment capacity. The other two factors are key drivers of performance. When you step back from it, what stands out is that it’s an index that was developed for its investment merit, and not for measuring the output of commodities. It’s an investment- driven index.
The other key benefit of the fund is that it does not issue a K-1 to shareholders. How do you avoid issuing one?
The first generation of commodity ETFs were structured in a way that they had to provide investors with a K-1 tax bill at the end of the year— something no investor wants. K-1s are often late and they’re always a pain to manage.
The problem is that the income created by commodity futures is not sanctioned by the Internal Revenue Service as eligible income. Newer commodity products—not just RCOM, but almost all newer commodity products—have figured out how to use a Cayman Island Trust to hold 25% of the portfolio, including the commodity futures contracts. The Cayman then provides an income stream to the fund that is viewed as eligible income by the IRS. This lets you get the commodities exposure you need but avoid a K-1; instead, the fund generates a normal 1099. It’s an elegant answer to an unsightly problem.
When will the fund beat a traditional commodity index, and when will it lag?
When you have an oil-led commodity market—and particularly if you get a spike in oil prices—RCOM will lag a production-weighted commodity index like the S&P GSCI, because those indexes are so heavily weighted in oil. Over time, however, the index RCOM tracks has performed extremely well. Year-to-date through Oct. 31, for instance, we are the No. 1-performing broad commodity ETF.
If we’re in a commodity depression, what are the benefits of owning RCOM?
If you look at a portfolio over the last five to 10 years, starting with a 60/40 portfolio, adding a 15% weight in RCOM would have boosted your risk-adjusted performance. Spot commodity prices are down, but we’ve had a very strong roll curve during that time, and commodities have played a nice diversifying role in the portfolio.
Is the fund liquid?
Because we’re in the early days and the fund is small, there is this misperception that the fund must not be liquid. But the largest holders of the funds are actually institutions, and they tended to come in at larger sizes with no issue. The futures contracts in the portfolio were selected for their liquidity. You could add tens of millions of dollars a day to the fund and have no impact on the trading.
If you had to sum up RCOM in one paragraph, what would you say?
Advisors need to go back to basics. They need exposure in their portfolios beyond equities and fixed income. We are facing a sustained low-return market for equities and a very low-yielding market for fixed income. Real estate may be near its peak.
Commodities is the one area that’s languished. But to take advantage of the recovery when it comes, you need a product that will benefit you while you wait. This has been a good index to do just that. And when the commodities market finally starts to turn, what’s good will become great. RCOM is the good-to-great portfolio.