Commodity ETF Spotlight: USCI In Focus

Many investors looking to add broad-based commodity exposure to their portfolios, ranging from individuals to billion dollar hedge funds, have turned to ETFs as the most efficient vehicle for doing so. While the most popular products are generally those that have the longest operating history, more and more investors are turning to new products that are popping up as a tool for establishing exposure to this potentially promising–and risky–asset class.

One of the more innovative commodity ETFs to debut in recent years is the United States Commodity Index Fund (USCI), which is the result of a collaboration between United States Commodity Funds, the firm behind the ultra-popular UNG and USO, and Summerhaven.

Vital Stats

Here’s a quick look at the basic facts of USCI:

  • Issuer: United States Commodity Funds
  • Index: SummerHaven Dynamic Commodity Index Total Return
  • Number of Commodities: 14 (from universe of 27 potential components)
  • Inception Date: August 2010
  • Expense Ratio: 0.95%
  • Assets: $426 million (as of 11/8/2011)
  • Structure: Partnership

Under The Hood

The commodities eligible for inclusion in the underlying index are presented in the following table (commodities included in the index as of November 2011 are emphasized):

Crude Oil (Brent) Crude Oil (WTI) Gas Oil
Heating Oil Natural Gas Unleaded Gasoline
Feeder Cattle Lean Hogs Live Cattle
Bean Oil Corn Soybeans
Soybean Meal Wheat Aluminum
Copper Lead Nickel
Tin Zinc Gold
Platinum Silver Cocoa
Coffee Cotton Sugar

Noteworthy Features

USCI is unique in that the underlying portfolio can change from month to month; out of 27 possible components, 14 are selected every month to make up the underlying index (and therefore the fund). This process is far from random; rather, the methodology is based on a significant amount of academic research into factors that can be predictive of above average returns from commodity futures.

Specifically, the underlying index is constructed in a two-step process:

1. The seven commodities with the highest percentage price difference between closest-to-expiration futures and next closest-to-expiration futures are included. In other words, those with the steepest degree of backwardation or most moderate contango are selected first.

2. Of the remaining 20 eligible commodities, those with the best price performance over the last year are selected for inclusion.

In constructing the basket of holdings, each commodity family (e.g., precious metals, agriculture) must be represented each month.

This methodology has the effect of potentially minimizing the adverse impact of contango on performance. Moreover, if backwardation in futures markets is an indication of tight inventories, this strategy can be effective for generating alpha within the commodities asset class. For investors looking to gain broad exposure to commodities, USCI is a compelling product that makes use of a unique approach to natural resource futures to bring potential return enhancement benefits to portfolios. It is, however, important to consider that the underlying assets are futures contracts; USCI, like other broad commodity ETPs, will not offer exposure to spot natural resource prices. In certain environments, the gap relative to a hypothetical “spot return” can be significant.

A couple other aspects of USCI are noteworthy. This product is organized as a partnership, and will be treated as such for tax purposes. That means that investors can generally expect to experience a tax event annually regardless of whether or not they sold shares, and can also expect to get a K-1 in the mail that will have to be completed.

It’s also important to consider that USCI is a bit more expensive than some of the other commodity ETPs out there. With a management fee of 0.95%, USCI is nearly twice as expensive as low-cost products such as DJCI.

How To Use

USCI can be used in a number of different ways, depending on investment objectives and risk restraints. This product certainly can have appeal to those building a long-term, buy-and-hold portfolio, though it generally makes sense to limit exposure to about 5% or 10% of total assets. USCI can also be a handy tool for more tactical exposure over a shorter period of time for investors looking to bet on a short-term pop in natural resource prices.

Disclosure: No positions at time of writing.

This entry was posted in Spotlight and tagged . Bookmark the permalink.

Commodity HQ is not an investment advisor, and any content published by Commodity HQ does not constitute individual investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities or investment assets. Read the full disclaimer here.

One Response to “Commodity ETF Spotlight: USCI In Focus”

  1. [...] This advantageous feature gives investors more control over their tax liabilities, making the ETN product structure optimal for investors looking to add commodity exposure to their long-term, buy-and-hold portfolios. Investors should note that GSP is subject to contango, seeing as how there is no clear cut methodology outlined for the maturity dates used, unlike the one-of-a-kind USCI [seeCommodity ETF Spotlight: USCI In Focus]. [...]

Leave a Reply

  • Subscribe

    • RSS Icon   Twitter Icon
    • Sign up for free today:
  • Search