ETF Watch: ETFS Debuts K-1 Free Commodity Funds

Today ETF Securities is rolling out three ETFs that will cover the commodity futures space while allowing investors to forgo the problematic issue presented by the K-1 tax forms usually required of futures-based funds. The products will list on the NYSE Arca with exceptionally low expense ratios for commodity ETFs.

The three ETFs and their expense ratios are as follows:

• ETFS Bloomberg All Commodity Strategy K-1 Free ETF (BCI), 0.29%
• ETFS Bloomberg All Commodity Longer Dated Strategy K-1 Free ETF (BCD), 0.29%
• ETFS Bloomberg Energy Commodity Longer Dated Strategy K-1 Free ETF (BEF), 0.39%

The funds’ expense ratios and the fact that there are no K-1 tax forms associated with them lie at the heart of their appeal and are a potentially powerful selling point.

For one thing, there are only a handful of commodity ETFs that come with lower expense ratios, almost all of which are precious metals funds. For example, the lowest-priced broad commodity fund until now was the PowerShares DB Commodity Index Tracking Fund (DBC), which has an expense ratio of 0.89%.

For another thing, K-1 forms—while a seemingly minor issue—can generate endless headaches for financial advisors and end users, often requiring extensions from the IRS due to reporting requirements that do not fall in line with the usual April 15 tax deadline, and generating extra (and more complicated) paperwork. Also, some wealth platforms have stopped adding new ETFs to their platforms if they require K-1s.

Puts Commodities Back On Radar

“By eliminating the K-1 issue, we’re thinking that—particularly for the advisor and RIA space—this puts commodities back on their radar,” said ETF Director and Head of US Product Matt Collins.

All three funds get around the issue of the K-1 tax form because they are structured as 1940 Act funds. Up to 25% of the portfolio—the futures portion representing 100% of the fund’s notional value—is held in a Cayman Islands-based subsidiary and tracks the futures index. The rest of the fund is held stateside and consists of a conservatively (but actively) managed portfolio of high-quality debt securities; this portion basically represents the collateral associated with the futures portion of the portfolio.

Active Component

“We’ll be very conservative in that aspect. I don’t think people are looking for us to select the next great corporate bond—but that’s the active component,” Collins said.

Although the funds are technically actively managed products, they will essentially track their underlying benchmarks. That means the broad commodity funds will invest in 22 commodities, while the energy ETF will cover natural gas, WTI crude oil, Brent crude oil, gasoline and heating oil.

The two “longer dated” strategies will invest in contracts with maturities between four and six months. According to ETFS, research shows this is the optimal spot on the futures curve for investors.

‘Best Middle Ground’

“You’ll find that the three-month forward is the best middle ground between giving sensitivity to spot but avoiding roll costs,” Collins noted.

“It’s the preferred institutional way of investing in commodities,” he added, pointing out that it makes front-running the fund more difficult, and takes the investment out of the congested area of the near-month futures contracts.

Arrow Adds Active Bond Fund

Arrow is launching an actively managed bond fund on the Bats exchange today. Bats is owned by ETF.com's parent company, CBOE. The Arrow Reserve Capital Management ETF (ARCM) comes with an expense ratio of 0.38% and targets a dollar-weighted average effective maturity of zero to two years.

ARCM invests only in debt denominated in U.S. dollars that is rated as Baa- or higher by Moody’s Investors Service or an equivalent rating by Fitch or Standard & Poor’s Ratings Services, the prospectus said. The fund can also use interest rate derivatives to hedge interest rate risk.

The prospectus specifically states that ARCM is not a money market fund, but notes that it looks to invest in short-duration securities that are likely to offer better returns and yields than money market funds.

Contact Heather Bell at [email protected].