Another Firm Joins ‘K-1 Free’ Trend

May 03, 2018

Today, USCF, the firm behind a host of well-known exchange-traded commodity products, has jumped onto the “K-1 Free” trend that is reshaping the commodity ETF space. The USCF SummerHaven Dynamic Commodity Strategy No K-1 Fund (SDCI), though technically actively managed, is designed to track the same index as that of the United States Commodity Index Fund (USCI).

SDCI comes with an expense ratio of 0.80% and lists on the NYSE Arca.

Structure

"SDCI has been a major component of our plan to offer investors truly diversified access to the commodity space,” said USCF President and CEO John Love.

“Investors have frequently asked for an investment vehicle that is guided by the SummerHaven Dynamic Commodity Index but that does not issue a K-1 tax form, and the ETF structure of SDCI enables us to do that,” he added.

USCI launched in 2010 and has $623.4 million in assets under management. SDCI is based on the same index but is structured as a 1940 Act fund, and as a result, does not issue the K-1 tax forms that have been a turnoff to many would-be commodity investors and advisors.

Like most similarly structured products, SDCI holds its futures contracts in a Cayman Islands subsidiary that can represent up to 25% of the fund’s total portfolio, while the onshore holdings consist mainly of U.S. government debt that serves as collateral for the futures portfolio and can also bring added returns to the fund.

SummerHaven Investment Management Partner Kurt Nelson says that this structure, which has only been used by ETFs for a few years, is where commodities are headed.

“We’re not trying to replace or displace any products, but it seems to be where the market is migrating,” he said, adding that, “it wasn’t clear that it mattered to investors until it did.”

He notes that other firms have launched “no K-1” versions of existing commodity funds, and some have gained significant assets.

Methodology

The underlying index selects 14 component futures contracts from a universe of 27 different commodities that fall into six key sectors (energy, precious metals, industrial metals, grains, softs and livestock). The first selects the seven commodities exhibiting the highest degree of backwardation or the least degree of contango, and then from the remaining pool selects the seven commodities exhibiting the highest price momentum over the prior 12-month period, the prospectus says.

If any of the six sectors are not represented by a futures contract, the methodology selects the highest-momentum commodity from that sector to be added to the index, replacing a lower-momentum commodity from a sector represented by multiple contracts, the document notes.

Full Suite

With the addition of SDCI, USCF now offers three products tied to the same index from SummerHaven Investment Management, which also serves as subadvisor to the products. There is of course USCI, the ETF structured as a 1933 Act fund, and then there is a traditional mutual fund, the USCF Commodity Strategy Fund (USCIX), which uses the same Cayman Islands subsidiary setup that SDCI uses.

According to Nelson, the SDCI is the final piece in the lineup, serving the investors who want their commodity exposure in an ETF wrapper but refuse to deal with the hassle and added cost of the K-1 form.

Also, the “no K-1” structure does reduce the costs, and not just from the investors’ angle. While SDCI has a total expense ratio of 0.80% and USCI has a management fee of 0.80%, the latter product actually has all-in costs of 1.03%, according to FactSet. Those added costs are mainly administrative and management costs associated with things like additional tax reporting and having to provide a K-1 form to every investor every year. 

“It’s more efficient from a sponsor point of view to provide a ’40 Act fund in that regard,” Nelson said.

Contact Heather Bell at [email protected]

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