Riding The Wave

September 01, 2005

WHAT NOW?

Having come this

far, the reader could conclude that there are not a lot of good alternatives currently available to most investors. Unfortunately, there is little to contradict this statement. This should be seen as a wake up call to both investors and product providers. Investors should realize that the current offerings are lacking. In many cases, a good idea badly implemented is worse than doing nothing at all. High fees, portfolio holdings that d o n't advance the concept of broad -based commodity indexation, improper benchmarking and the use of inappropriate surrogates all tend to negate the positive reasons for investing in commodities in the first place.

Ideally, product providers would strive to address the issues identified in this article and provide products which strive to address the following points:

1. Perhaps the single most significant change that product providers could make is to reduce the fee and expense structure of the various commingled fund structures. Early in a new product life cycle, higher fees can be expected. As the products become more prevalent, however, expenses should decrease. Although commodity-linked assets under management have grown tremendously over the past few years, there has been almost no significant reduction in expenses charged to the investor.

Figure 20

Real Asset Funds-Expense Structure Examples

Fund

Expense Ratio (%)

Front Load (%)

Deferred Load (%)

PIMCO Commodity Real Ret Strat A

1.24

5.50

0.0

PIMCO Commodity Real Ret Strat B

1.99

0.00

5.00

PIMCO Commodity Real Ret Strat C

1.99

0.00

1.00

Oppenheimer Real Asset A

1.40

5.75

0.00

Oppenheimer Real Asset B

2.31

0.00

5.00

Oppenheimer Real Asset C

2.24

0.00

1.00

Merrill Lynch Natural Resources A

1.25

5.25

0.00

Merrill Lynch Natural Resources B

2.02

0.00

4.00

Merrill Lynch Natural Resources C

2.02

0.00

1.00

Ivy Global Natural Resources A

1.65

5.75

0.00

Ivy Global Natural Resources B

2.42

0.00

5.00

Ivy Global Natural Resources C

2.38

0.00

1.00

Source: Morningstar.com

2. All returns should be benchmarked to an index that is transparent, rules-based and widely disseminated. This means that the composition of a model portfolio is readily known, that individual constituent prices are widely available, and that the price change of the index can be broken out and attributed to the various components. Product providers should track the investment performance on an individual component and/or sector level, and should make this information available to investors in a timely manner. Index specifics, such as composition, rebalancing timing and calculation methodology, should be prominently identified.

3. As has been discussed, some index methodologies allow for significant portions of the invested funds to be available for enhanced strategies. In many cases, portfolios that are nominally benchmarked to a broad commodity index contain other high yield assets, such as junk bonds. If this is done, it should be noted and explained in detail. Ideally, the commodity return portion of the portfolio would be benchmarked to the commodity index and reported alongside the performance of these other investments, which should also be bench-marked (perhaps versus 90-day T-bills). In this way, investors could make informed decisions regarding the management of the commodity portfolio versus that of the non-margined allocation.

4.  Investors should know if their investment is backed by actual commodity proxies and represents an ownership interest in this underlying basket of products. Holdings transparency and adherence to published index rules and conventions should ensure that investors actually get the exposure that they think they are getting when they invest.

5.  Benchmark transparency should be such that market professionals are able to calculate index prices independently throughout the day and maintain replication positions. An open-ended structure would allow these market participants to enter the market and would provide an arbitrage mechanism, which would lead to more accurate pricing and increased liquidity.

6.  Finally, investors should be able to trade shares in the products intraday, like stocks. Initial investment thresholds should be low enough to allow all investors to include these products in their strategic investment planning.

These suggestions re p resent the product model that providers should be attempting to attain. Investors should not expect to see all of these features in a single product, nor should they expect them to appear all at once. In some cases, they could not all be included in the same product. Rather, innovative product providers will address these issues piecemeal and provide products that will gradually move us t o w a rd the goals set forth herein. For instance, regulatory issues cannot be pushed forw a rd any faster than they take to move through the system. Exchange-traded products are subject to this approval process, and cannot be offered until they are approved. The timing, there f o re, is largely out of the hands of the product providers once the application process has begun.

In the short-term, however, there is no good reason why commingled funds with direct commodity exposure and low fees have not been introduced. The time is right for those who choose to lead by innovation. The market has shown incredible growth in spite of the current product offerings- not because of them. Imagine what could happen with a well-designed product that addressed these issues.

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