Ag ETFs Weathering Storm

September 08, 2011


In mid-August, the Federal Reserve surprised markets by pledging to keep interest rates near zero percent at least until mid-2013. The Fed also said it would stand ready to act if the economic outlook worsened, hinting at further stimulus, which many economists consider to be inflationary.

For investors considering diversifying into agriculture, there are fundamental differences between the two funds that should be understood before making an investment decision.

DBA is structured as a partnership for tax purposes and holds futures contracts. Therefore, 60 percent of gains are taxed at the long-term rate, with the remaining 40 percent taxed at the short-term rate, regardless of how long the shares are held. This comes out to a 23 percent blended maximum rate.

DBA is also marked-to-market at year-end, so investors can be subject to pay taxes on any gains even if shares aren’t sold. Finally, gains and losses are reported on a schedule K-1 form, instead of the 1099 that most investors are accustomed to.

RJA, on the other hand, is an ETN and actually doesn’t need to hold anything—it’s simply an unsecured debt note that tracks its underlying index. For tax purposes, RJA is currently taxed at the 15 percent long-term rate if held for more than a year, and taxed as ordinary income if shares are held for a year or less.

The catch is that RJA carries credit risk of the bank issuing the note. It’s crucial to note that even though RJA is a Merrill Lynch product, the bank issuing the note isn’t Bank of America, but rather the Swedish Export Credit Corp.

So, DBA and RJA can be beneficial to different types of investors, depending on your time horizon and personal preferences regarding taxes and credit risk.

Investors often seek diversification using different global equity and fixed-income funds, but due to increased integrated global markets, it’s getting difficult to find uncorrelated funds.

Both DBA and RJA continue to look like good diversification plays, and have shown the importance of being diversified not only across various funds, but also across different asset classes.

Disclosure: I am currently long RJA.

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