PowerShares DB Agriculture ETF Forced to Buy Alternative Futures

By Matthew Hougan

Want to know how big the commodity boom is? The PowerShares DB Agriculture ETF—or DBA—is basically full.

More accurately, the fund-which invests in commodity futures contracts-has reached its position limits in some of its commodities.

The commodity exchanges and the Commodity Futures Trading Commission set maximum amounts that certain investors can hold in individual commodities. DBA's assets have soared recently, adding nearly $1 billion in assets in February alone (to hit $2.8 billion), and that asset growth has pushed the fund against CFTC position limits. As a result, as PowerShares DB said in this filing with the SEC, DBA has started trying to replicate the returns of the index by investing in futures that are similar ... but not identical ... to those in the index itself.

Right now, here's the split between what the index tracks and what the fund actually holds.

DBA Index			DBA Fund
Contract	Expiration	Weight	Contract	Expiration	Weight
Corn	12-Dec-2008	22.94%	Corn	12-Dec-2008	13.76%
			Corn	14-Jul-2008	8.70%
Wheat	14-Jul-2008	25.92%	Wheat	14-Jul-2008	9.52%
			Wheat	12-Dec-2008	2.89%
			Wheat (Kansas)	14-Jul-2008	9.52%
			Wheat (Kansas)	12-Dec-2008	3.05%
			Wheat (Minneapolis)	14-Jul-2008	1.52%
Soybeans	14-Nov-2008	25.8%	Soybeans	14-Nov-2008	16.68%
			Soybeans	14-Jan-2009	8.91%
			Soybean Meal	12-Dec-2008	0.02%
Sugar #11	30-Jun-2008	25.33%	Sugar #11	30-Jun-2008	24.77%

As you can see, the fund has tweaked its holdings in three ways.

First, it has started buying contracts with different expiration dates. For instance, the index tracks the performance of the corn futures contract expiring in December 2008. But the fund includes both that contract and a separate contract expiring in July 2008. Historically, those two have tracked very close to one another, but of course, that doesn't have to be the case.

The second thing the fund has done is buy contracts on different exchanges. In the wheat markets, the fund has diversified beyond Chicago wheat contracts to buy contracts in both Kansas City and Minneapolis. But these contracts don't just trade on different exchanges, they are actually different kinds of wheat: Soft Red Winter Wheat (Chicago), Hard Red Winter Wheat (Kansas City) and Hard Red Spring Wheat (Minneapolis).

These different varieties tend to perform in similar ways, but not always. They serve different kinds of markets and, because the harvests come due at different times, they can be impacted by different seasonal and weather patterns. Minneapolis wheat, for instance, has seen extraordinary gains recently due to near-term crop shortages.

Finally, the index has diversified into alternate or "derivative" contracts for soybeans, buying not just the beans themselves but soybean meal as well. These two products are related, but of course, they do not track perfectly.

Should any of this worry investors? Not necessarily. This fund still offers strong exposure to the agricultural futures market.

But it does raise some concerns. Deutsche Bank, for instance, claims that the underlying index is designed to pick the most profitable contracts for each commodity based on the expected roll yield. Simple logic, then, suggests that alternate contracts could be suboptimal. And the addition of different types of contracts raises some tracking risk against the index.

The CFTC is reconsidering the limits it places on investors, and may increase them in the future. If they don't, we may see more funds adopt the model of DBA and using alternate contracts to try to approximate the returns of the index itself.

This may in the long term give an advantage to the exchange-traded note structure, as notes won't be directly limited in size.

Comments

[mangy cat:]

when my broker suggested i take a position in dba
my rejoinder was:
a) commodities firm, but on long term plateau, rather than up for a further escalation
b) dba is too concentrated, personally would go for rja etn (more confidence in swedish export bank being there at the end, than barclays and now lehman)
c) already holding a position in moo and agribusiness equities individualy (ok, he was unaware of the moo holding and some of the agri-corps)
d) commodity boom prices associated with export duties, therefore fiscal performance, therefore the risk in argie govt bond holdings

this said, although diversification will almost certainly increase tracking error, at the bottom line it ain't a bad thing for investors

incidentally, lehman etn has 58% in soya (beans, meal and oil)

2008 Mar 05 07:31 AM

[mangy cat:]

forgot to mention in point b), rja got cocoa frost impact which is outside my grain radar

2008 Mar 05 09:12 AM

[sbenard:]

Perhaps the last sentence of the article is -- long term -- the most significant. ETN's may hold the advantage here.

Thanks for the article.

2008 Mar 05 02:53 PM