PowerShares' Smart Decision To Leverage Commodity ETFs

Includes: DBP, DBS, DGL
by: IndexUniverse

PowerShares is planning to leverage up three of its commodity futures exchange-traded funds (ETFs) to provide 200 percent of the daily return of the underlying indexes. The company has asked shareholders to approve the change for three funds:

  • PowerShares DB Precious Metals Fund (NYSEARCA:DBP)
  • PowerShares DB Gold Fund (NYSEARCA:DGL)
  • PowerShares DB Silver Fund (NYSEARCA:DBS)

The proxy is available here.

These funds currently track the performance of a fully collateralized futures position in the relevant commodity or commodities, meaning they capture changes in the spot price plus any "roll yield" and interest income. Under the proposed structure, the funds would instead try to double the underlying index movement. If the indexes do well, this could be a very, very good thing. If they do poorly, it could be very, very bad.

If approved, these will become the first leveraged commodities ETFs. ProShares launched a family of leveraged equity ETFs in 2006 that have now gathered over $8 billion in assets.

PowerShares will not lever up its remaining commodity funds, such as the popular PowerShares DB Commodity Index Tracking Fund (NYSEARCA:DBC) or the PowerShares DB Agriculture Fund (NYSEARCA:DBA). Those funds have gained significantly more traction with investors than the precious metals funds, which probably explains the decision to lever one and not the other.

Shareholders have until October 9 to vote on the proposed change in the funds.

Why Leverage?

The decision to leverage up the funds is probably a smart one. To date, the funds have gained limited traction with investors; each of the funds holds only around $20 million in assets. For a variety of reasons, precious metals investors looking in the ETF space have favored "physical bullion" ETFs such as the streetTRACKS Gold ETF (NYSEARCA:GLD), which holds physical gold bullion in a vault as its only asset and currently has nearly $14 billion in assets. The physical bullion ETFs are cheaper and (in some circumstances) have improved tax consequences. More importantly, investors appear to prefer the solidity of bullion-backed funds over the ethereal nature of futures contracts.

By levering the funds, however, PowerShares will create a different dynamic. Gold, silver and other precious metals have emerged as major trading tools in the market, with investors using them as proxies for fast-moving trends in the market. ProShares has had significant success servicing this trading market with its leveraged equity ETFs, and PowerShares may find traction with its leveraged approach as well.

Written by Matthew Hougan