The new funds are the:
PowerShares DB Energy Fund (DBE)
PowerShares DB Oil Fund (DBO)
PowerShares DB Precious Metals Fund (DBP)
PowerShares DB Gold Fund (DGL)
PowerShares DB Silver Fund (DBS)
PowerShares DB Base Metals Fund (DBB)
PowerShares DB Agriculture Fund (DBA)
You can find the prospectus here.
Like DBC, the funds track the performance of fully collateralized futures investment in the given commodity or commodities. That means that each fund gets its returns from three sources:
1) Changes in the spot price.
2) Collateral interest, i.e., money not invested in futures is invested in Treasuries.
3) Roll yield, i.e., the price difference (positive or negative) achieved each time a contract is rolled from one expiring futures contract to another.
The oil, gold and silver funds will charge 50 basis points; the other funds will charge 75 basis points. Those expenses will be covered by the collateral interest income, which will approach 5 percent per year based on current interest rates.
Like DBC, the new ETFs track something Deutsche Bank calls its “Optimum Yield” indexes. All futures-based indexes must roll their contracts from one month to the next as each contract expires; typically, they simply sell the expiring contract and purchase the next, i.e., sell January and purchase February.
The “Optimum Yield” indexes, however, instead have the flexibility to “select” the best-priced contract looking out as far as 13 months. That is supposed to improve the “roll yield.” As explained below, PowerShares and DB are making some bold claims about the robustness of this process; it remains to be seen whether those claims will hold up over the long hall.
Potential Uses And Concerns
Investors can work with the funds in different ways. The most obvious use is to go long or short one particular sector – say, to make a bet on agriculture, energy or silver. In most cases – and particularly in the case of the agriculture and base metals ETFs - the funds offer the first opportunity for ETF investors to make a futures-based investment in each sector.
Investors can also use the funds to create a “pairs trade” with a broad-based commodity index ETF. For instance, you could buy the broad-based DBC but hedge against the current negative roll yield in the energy sector by shorting the PowerShares DB Energy Fund.
The funds, however, have unique quirks, which should be considered by investors looking for a commodities investment.
The gold, silver and precious metals funds will provide an interesting counterpoint to the existing gold and silver bullion ETFs. The bullion ETFs, such as the $8 billion streetTRACKS Gold Shares (GLD), are taxed as “collectibles” like other bullion holdings, with a long-term capital gains tax rate of 28 percent. Since the new ETFs rely on futures, however, any gains are taxed 60 percent as long-term gains and 40 percent as short-term gains, creating a maximum blended tax rate of 23 percent.
That would seem to put the futures funds and an advantage. However, the different ETF styles do not provide identical performance. Gold futures have historically traded in contango, which hurts futures-based returns; at the same time, gold futures investors also earn collateral interest, which offsets the contango losses. The result is that the long-term performance is close: using backtested results, PowerShares says that its gold futures fund would have outperformed spot gold over the past 10 years, posting a 5.1 percent annualized return compared to 4.7 percent for spot gold.
Oil and Energy
The most controversial of the new ETFs may be the new oil fund (DBO), which will compete head-to-head with two competing contracts, the $750 million U.S. Oil Fund (USO) and the recently launched MACROshares oil contracts. The comparisons are interesting because the crude oil futures market has been stuck in a vicious contango recently, and the three products offer vastly different exposures to contango and the roll yield.
USO takes the traditional approach, simply rolling forward from one contract to the next as each expires. This has the benefit of liquidity and of limiting duration risk, but it leaves the fund fully exposed to any contango concerns. The MACROs, meanwhile, largely dodge much of the roll yield issue; they have an unusual product structure that allows them to track closer to spot crude. This is good when the markets are in contango, and bad if they switch to backwardation.
PowerShares makes very bold claims about the impact of DB’s “Optimum Yield” strategy on mitigating effect if contango and enhancing the impact of any backwardation. According to the prospectus, the Goldman Sachs Crude Oil Total Return Index (similar to USO) has dropped 17.4 percent over the past year, while the PowerShares fund would have gained 5.2 percent (spot crude was down about 1 percent).
Stretching back over 3 years, the difference between the Goldman Sachs position and the PowerShares position is significantly enhanced: 41.7 percent annualized return for PowerShares DB vs. an 18.2 percent annualized return for Goldman Sachs.
Those are huge differentials any way you cut it, and investors should remember that backtested results aren’t necessarily reliable. That said, the Optimum Yield strategy is an interesting approach, and bears watching, particularly in energy-related markets.
The easiest analogy to draw about these funds is to compare them to the popular stock sector ETFs, which have become a huge hit with investors and financial advisors, who use them to make specific bets or to craft an asset allocation policy. That’s a bit less likely to happen on a broad scale with the commodities ETFs, as fewer investors will (or should) feel comfortable trying to execute those complicated strategies. Still, expect to see the market pundits telling you to “go long Agriculture" to capture the ethanol boom, Agriculture also happens to be a part of the futures market less prone to contango effect.
The new PowerShares funds are good funds. It’s good to see U.S. ETF providers catching up with their European peers, who have had access to sector-based commodity ETFs from ETF Securities for months now. The funds will likely take a bit of time to catch on, but their appeal is obvious.