Commodity exchange traded funds
Exchange Traded Funds (ETFs) are a new type of securities that are available to investors seeking to invest in a specific type of asset, commodity, index, or industry with minimal risks. They can be best described as a blend of shares and mutual fund units.
Some of the similarities between ETFs and mutual funds are:
a. ETFs are pooled funds like mutual funds;
b. ETFs have a fund manager like mutual funds;
c. ETFs are diversified funds like mutual funds;
d. ETFs can also be close ended or open ended funds like mutual funds;
e. ETFs also have two forms of distribution, i.e., dividend and capital gains distribution, like the mutual funds;
f. ETFs too have a net asset value, though it fluctuates throughout the day, unlike mutual funds, where the NAV is fixed at the closing hour;
ETFs give investors a chance to trade in a new set of assets, which were never traded before on stock exchanges, like foreign exchange, silver, gold, oil, index investments as a bunch, specific industry stocks, etc.
Formerly, if an investor desired to speculate in gold, or oil, he or she would be forced to take up shares in gem and jewels industry, and or gold mining industry, which also dabbled in gold trading. However, investor could not invest in specific activity of gold trading and pricing through stock exchanges, as he is able to do now with the help of ETFs.
With ETFs, an investor can speculate even with a small amount in assets requiring large amount of investment, like gold and real estate.
Other crucial advantages of ETFs over mutual funds are:
a. ETFs can be traded on stock exchanges, unlike mutual funds; therefore, they also offer better liquidity;
b. ETF units may have a higher value than their underlying class of assets because of demand generated by affordability; this is not true in case of mutual funds;
c. ETFs are more cost effective than mutual funds because of lower commission, and other charges;
d. ETFs facilitate better tax planning than mutual funds;
e. ETFs also facilitate trading of commodities like bullion, oil, foreign exchange, and other agricultural or mining products through stock exchanges route. Before ETFs were introduced, investment in these markets through stock exchanges was not possible.
Investors also have an option to invest in individual shares from which they expect good returns. However, buying and selling shares is expensive as it entails brokerage charges both ways. In addition, the funds outlay required to achieve a diversified portfolio, is larger. Therefore, ETFs are a risk mitigating diversified portfolio option available to the investors.
Commodity Exchange Traded Funds
Of the different forms of Exchange Traded Funds, commodity exchange traded funds or Exchange Traded Commodities (ETC) form a major chunk.
ETC can be broadly divided into four categories; namely
a. Bullion , as of date, this category covers Gold Exchange Traded Funds and Silver Exchange Traded Funds. Other metals like Platinum and Copper may soon join the list.
World Gold Council sponsors the GETFs. Trading in GETFs started in Australia, spread to other countries like USA, UK, Germany, France, Italy, Singapore, India, South Africa, and Japan.
Investment companies, banks, or other financial institutions launch such funds. They buy some gold and pool it, taking credit for their respective contributions in form of units of gold, in paper. These units are than sold to retail investors, thereby letting the institution or banker recover their funds with slight profit. The pooled gold is placed in the safe deposit vaults of World Gold Council. Each unit with the investor represents some part of that gold, and investor is assured of his or her rights on that gold.
Examples of GETFs are:
a. iShares COMEX Gold Trust that is issued by iShares. This GETF is traded on NYSE
b. ETF securities from ETFS Gold are another set of funds that follow the trend in gold and gold index. This is traded on London Stock Exchange
c. street TRACKS Gold Shares is perhaps the most famous one and it is traded on NYSE.
Examples of Silver Exchange Traded Funds are:
a. iShares Silver Trust, from Barclays Global Investors.
b. Currency and foreign exchange related ETCs, in this type of ETFs, the underlying asset is a chosen currency. Funds generated are invested in the currency, when the currency is low, and liquidated when the currency scales unreasonable heights. Example - Rydex Euro Currency Trust.
c. Basic commodity basket containing edible oils, sugar, wheat, rice, pulses, etc., is another sphere that was excluded from participating in stock market. ETF or ETCs have become a method of investing in these commodities and trading them on stock exchange. Even other metals like Zinc, Tin, and Aluminum, and their ores are valuables. ETF is being launched by Deutsch Bank, which will facilitate speculation on trading of such commodities.
d. Oil, Petroleum and Gas affect all economies. Therefore, their prices are extremely vulnerable to demand and supply in the markets. This is another area that was hitherto untapped by investors. Investors could not invest in purely oil trading activity; they had to settle for industries that extracted, refined and sold to other retailers. Trading in oil as a separate and sole activity has become feasible with Oil Exchange Traded Funds. Examples include proposed Ameristock Funds New York Oil ETF from Ameristock.
Regulatory environment:
As ETFs have both shares as well as mutual funds characteristics, they are subject to regulations of Securities and Exchanges boards of their countries and the mutual fund regulations, apart from companies act provisions. These regulations basically focus on manner of pooling and deployment of funds, and dissemination of information to stakeholders.
Risks:
ETF investments are subject to market risks. The risks can include, reliance on wrong information like in Enron's case, or sudden spurt in demand for oil due to some political developments in Middle East, etc. In addition, sudden liquidation by a major shareholder may force the other investors to forgo reasonable market price. If, for any reason, the fund goes into liquidation, the investor may lose his rights on all underlying assets of the fund, despite the fact that his personal finances are nowhere near bankruptcy stage. Market cycles of commodities are another fact that needs to be closely examined, keeping in view different historic trends related to the commodity.Other Articles
