Tag Archives: PowerShares DB Commodity Index Tracking Fund

When Exchange-Traded Notes Trump ETFs

On the surface, exchange-traded notes appear similar to their more popular cousins, exchange-traded funds. Both seek to match some sort of market barometer, and both offer similar advantages over actively managed mutual funds: lower fees, lower investment minimums and greater tax efficiency. And, like stocks, you can trade them throughout the day.

But don’t be misled. ETFs and ETNs are very different animals. ETFs mimic the indexes they track by holding a diversified collection of securities, such as stocks or bonds. ETNs, however, don’t own anything. An ETN is an unsecured debt that is typically issued by an investment bank. Like an ETF, an ETN tracks an index. But when you invest in a note, you’re merely buying a promise from the issuer to pay you the index’s return, minus fees.

So when you buy an ETN, you not only take a chance on whatever index the note seeks to copy, you also assume the risk that the issuer could fail to make good on its promise. Investors in three ETNs sponsored by Lehman Brothers got a taste of that sort of risk after Leh­man went belly up in 2008. So far, none of its creditors, including its ETN investors, has received a penny.

So Why Buy ETNs?

Even with all that extra risk, notes do have some advantages. For starters, ETNs offer access to hard-to-reach asset classes and investment strategies (we’ll discuss some of them later). Moreover, although ETFs are subject to tracking error — that is, the chance that the fund will not move precisely in sync with the index it’s designed to match — ETNs are not.

ETNs are also more tax-friendly than ETFs. ETFs, like mutual funds, must distribute annually to shareholders all the interest and dividends they collect from the securities they hold. Investors who receive these distributions in taxable accounts must share their earnings with the IRS at rates as high as 35%. An ETN, by contrast, reflects the collection of dividends and interest by adjusting its net asset value, so you don’t pay taxes until you sell the ETN. And if you hold an ETN for more than a year, you pay the long-term capital-gains tax rate of 15%.

Commodity-oriented ETNs also have a tax edge over similar exchange-traded products. With a commodity ETN, you pay taxes when you sell, allowing you to pay the favorable capital-gains tax rate if you hold the ETN for more than a year. Most exchange-traded commodity funds invest in futures contracts and are set up as limited partnerships. That means investors have to tackle potentially complex Schedule K1 forms. Moreover, you must pay taxes on any capital gains the ETF realized during the year, even if you didn’t sell any shares. In addition, ETFs that hold precious metals, such as gold, are taxed as collectibles, at a maximum rate of 28%, not 15%. (Currency ETNs don’t have the same advantage as other ETNs; interest from these ETNs is taxed as ordinary income on an annual basis.)

4 ETNs Worth a Look

In each case we list below, the ETN either offers advantages over comparable ETFs or provides a strategy that is unavailable with an ETF.

Commodities. Because of the tax pluses, investors may find Elements Linked to the Rogers International Com­modity Index — Total Return (RJI) the best way to invest in stuff. Issued by the Swedish Export Credit Corp., RJI is the fourth-largest ETN in the U.S., with $919 million in assets. It follows a benchmark of 38 commodities created by Jim Rogers, a commodity expert and author. The index has a 44% weighting in energy, 35% in agricultural products and 21% in precious and base metals. Over the past year, the ETN returned 40.4%, compared with 37.9% for PowerShares DB Commodity Index Tracking Fund (DBC), the largest commodity-oriented ETF (all returns are through June 3). The ETN’s annual expense ratio is 0.75%.

For the full story and other three ETNs, go to Kiplinger.com.

All That Glitters Is Not Gold

In times of economic crisis, investors and regular citizens scared-out-of-their-minds turn to gold. As a gift, I like to say it’s always the right size and the right color. But as an investment, it’s an asset that is supposed to hold a steady value. While demand for gold can push the precious metal’s price higher, it’s value can also rise on a relative basis. Specifically, as the dollar continues to fall in value, it takes more of them to buy the same ounce of gold. So, if you think the stimulus plan might devalue the U.S. dollar and you don’t know where to invest, it may be a good time for gold.

With gold up year-to-date 4.97% as of Feb. 6, compared with 4.32% for all of 2008, ETFGuide compares the 2008 returns of four exchange-traded vehicles (ETVs).

SPDR Gold Trust (GLD) up 2.99%
Market Vectors Gold Miners ETF (GDX) down 26.65%
PowerShares DB Commodity Index Tracking Fund (DBC) down 30.77%
ProShares Ultra Gold (UGL) n/a, launched in Dec. 2008

I look at three more.

iShares Comex Gold Trust (IAU)
PowerShare DB Gold Fund
PowerShares DB Precious Metals Fund

The Gold Trust, up 4.92% this year through Feb 6., did the best because it holds real, solid gold bricks in a vault in London. If you want to own gold and not have to store it, this is the way to go. This or iShares Comex Gold Trust (IAU), which is up 5.11% as of Friday. These are not true funds, but grantor trusts. Shareholders are taxed as if they own the underlying gold, with a long-term gain tax rate of 28%.

The Market Vectors Gold Miners is an ETF that holds stocks. So, even though the commodity gold went up, the stocks fell because they were caught up in the macro downtrend of the broader stock market. The S&P 500 lost about 38% last year, so the rising price of gold helped the ETF’s returns, still beating the S&P 500 by 11 percentage points doesn’t feel so good when you lost 27% of your investment. Gold stocks will give leverage over the commodity, up to three times the percentage gain in the price of gold, but that leverage also works on the way down. Year-to-date Gold Miners is down 26% according to Yahoo Finance. Because Market Vectors holds stocks the current long-term capital gain tax rate of 15% applies.

PowerShares DBC holds futures contracts, but only about 10% is comprised of gold contracts, so it’s not a pure play. But it is a good way to play the broader commodity sector by tracking an index. Obviously, 2008 wasn’t a great year for commodities either. DBC is taxed like futures contracts. Capital gains are taxed 60% at the long-term rate and 40% at the short term rate.

ETFGuide doesn’t look at PowerShare DB Gold Fund (DGL), which holds only gold futures contracts. The DGL rose 3.2% last year and is up 2.61% year-to-date. There’s also the PowerShares DB Precious Metals Fund (DBP), which is comprised of 80% gold and 20% silver. It slid 1.12% last year and is down 3% year-to-date.

The price of one ounce of gold closed at $895 on the London Bullion Market, down from $920 last Thursday.

For a detailed explanation of the gold and all the other ETV tracking commodities check out ETFs for the Long Run: Chapter 8: The ETFs That Aren’t ETFs.