Biofuels & Ag ETNs Join Growing Renewable Energy Market

February 08, 2008

Pair of new ETNs launch on Amex, slicing-and-dicing commodities even more.

In the quest for better sources of renewable energy, agricultural commodities used to create it are trading at record levels around the world.

As a result, two new exchange-traded notes (ETNs) have been launched in the U.S. Just out and trading are the Elements MLCX Biofuels (AMEX: FUE) and the Elements MLCX Grains (AMEX: GRU). The notes for both are issued by AB Svensk Ekportkredit (Swedish Export Credit Corporation). The Amex specialist unit is Susquehanna Investment Group.

The ETNs are based on benchmarks developed by Merrill Lynch. The biofuels index includes several key commodities tied to feed stocks. Those include sugar, corn, soybeans, canola and soybean oil, among others. The index's weightings reflect production levels and measures of economic value.

The biofuels index is designed to implement a more efficient way of rolling agriculture and other futures contracts with differing expiration dates. According to information supplied by Merrill Lynch when the new benchmarks were created last year, the methodology used can spread the process of moving in and out of commodities across about a two-week time frame.

"Our indices have been carefully designed to mitigate the negative roll returns inherent to many agricultural commodities markets," Merrill Lynch's Francisco Blanch told Biofuel Review last October. "They also offer additional returns by overweighting crops that produce the most energy in biofuel production, notably sugar and soybeans."

The parceling of this hot area into biofuels and related agricultural commodities joins an ever-growing field. Other more diversified exchange-traded funds (ETFs) already out include The PowerShares Deutsche Bank Commodity Index (AMEX: DBC) and the iShares GSCI Commodity Index Trust (NYSE: GSG).

"The ETF structure of DBC and GSG allow the funds to piggyback on the popularity and success of other ETFs. However, they are more complicated, more expensive and less precise in their slippage than other ETFs, as well as other commodity-linked vehicles," wrote David Krein, president of DTB Capital, in a review of commodities indexes and funds for the January/February 2007 issue of Journal of Indexes.

"These ETFs may be suitable for retail or buy-and-hold investors that are looking for a quick, comfortable solution, but professional and more discerning investors will likely turn to other instruments for comparable exposure," he added.

On the other hand, ETNs are more specifically designed to work within commodity markets, according to Krein. "ETNs strike some as complicated, but they are actually fairly straightforward: ETNs are structured like debt, traded like equity, and deliver the performance of a commodity index," he said in the research piece.

Krein's analysis came before the government ruled that ETNs won't receive as favorable tax treatment as once believed.

But he did point out that ETNs were new investment vehicles. His in-depth article also gave little doubt that developments in creating new indexes and products were part of an ongoing process and open to further review.

Krein also made references to a trio of broad-based ETNs on the market: the iPath GSCI Total Return Index ETN (NYSE: GSP); the iPath Dow Jones-AIG Commodity Index Total Return ETN (NYSE: DJP); and the iPath Goldman Sachs Crude Oil Total Return Index ETN (NYSE: OIL).

In either case of choosing between an ETF or ETN to provide commodities exposure, Krein said that traditional index mutual funds won't suffice.

"Commodity mutual funds have served their purpose in building interest in this market among non-professional investors," he wrote. "However, the relatively high fees, unresolved tax complications and wide variety of liquid and transparent alternatives with similar exposure mean that it is time to shift away from this vehicle."

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