K-1 Taxes Hurdle For Commodity ETFs

April 09, 2018

K-1s: Commodity Pools' Biggest Downside

Each year, commodity-pool ETFs issue Schedule K-1 forms to report each partner/investor's share of the profits and losses that the fund accrued:

 

Sample K-1 Form for PowerShares DB Silver Fund

Source: PowerShares

 

To generate these forms, the fund managers must first collate ownership data, which usually isn't provided by brokers until late January. That pushes out mailings of K-1s to investors to March.

If K-1s don't come in time, however, the investor must file and pay for an extension with the IRS. For advisors serving lots of clients, K-1-related delays can result in more paperwork and more headaches.

More Taxes, Every Year

The problem isn't just in the paperwork. Commodity-pool ETFs mark to market their gains, losses and income made throughout the year, then pass on the tax liability to their shareholders. That means if your commodity ETF has a good year, you'll probably have to write a check to the IRS, even if you didn't touch your shares.

For buy-and-hold investors, these annual taxes have the potential to erode long-term returns. Compare the aforementioned DBC to the PowerShares Optimum Yield Diversified Commodity Strategy No K-1 Portfolio (PDBC), which has a nearly identical portfolio to DBC, but is structured as a '40 Act fund. DBC has dropped 3.09% over a three-year period, while PBDC has dropped only 2.91%. (It's unclear how much of this difference could be explained by PBDC's 0.30% lower expense ratio, however.)

Commodity Pools Are More Expensive

One infrequently mentioned downside of commodity pool ETFs is that they just plain cost more than other types of commodity ETFs.

On average, commodity ETFs that issue K-1s are 0.36% more expensive than commodity ETFs that issue only 1099s. That's not for nothing, considering the average expense ratio for a commodity ETF is already a hefty 0.87%.

The reason at least some commodity pools are more expensive is, in part, due to a lack of competitive pressure. The Teucrium Corn Fund (CORN), for example, is the only pure-play corn ETF on the market; as such, it can carry a 2.66% expense ratio with impunity. Same goes for the only soybeans ETF on the market, the Teucrium Soybean Fund (SOYB), and the only wheat fund, the Teucrium Wheat Fund (WEAT), which carry expense ratios of 2.63% and 2.54% each.

In other cases, commodity-pool ETFs were among the first funds in their respective categories; USO is the oldest crude oil fund, for example; and the PowerShares DB Agriculture Fund (DBA) is the oldest agriculture ETF. As such, these ETFs had considerable first-mover advantage over their newer, potentially cheaper peers.

 

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