Exchange Traded Funds America’s Latest Sizzling Commodity

Written by admin on May 24th, 2011

Exchange Traded Funds

In recent years, there is one type of fund that has hit the commodities market creating a major impact. This comes in the form of exchange traded funds. United States markets alone hold more than billion in assets, as of 2009. The investor has many choices when it comes to using these funds. They use them to purchase exposure to individual commodity sectors, gold, oil, broad-based commodity futures indexes, and silver. What makes these funds so popular is the fact that they are very easy to purchase. They are purchased as an exchange-traded fund as an investor would purchase any other security. Exchange traded funds are considered very affordable because there is no commission charge for purchase and they cost approximately 75% less than a commodity mutual fund.

Exchange-Traded Funds Linked to Individual commodities Futures

Futures are very popular with investors, which can be considered the home of commodities-linked exchange trade funds. The way this works is that this type of fund will buy futures with leverage, but they will only offer a small part of the cost of the contract. Then the remaining balance will go to treasuries, who will in turn generate income from the interest that is accumulated. When an investor begins to inquire about the return he or she will get on their investment, the answer can be increasingly complicated. This is because it is based on many different contingencies that begin with roll yield, collateral interest income, and ends with any changes in spot price.

Exchange-Trade Funds Taxes

This can be a very tricky subject when it comes to exchange-trade funds. Essentially, the IRS requires investors to sell their exchange-traded funds by December 31 of each year. It is important to remember that if the fund is up then taxes will be owed. This is because there is no deferment when it comes to gains on commodity futures. It is vital to remember that all gains are taxed at a rate of 60 percent for long-term gains and 40 percent for short term; this is true not matter the holding time period.  There is also a tax on the interest. Capital gains also cannot be deferred and they are taxed to a maximum of 23 percent.

Exchange-Traded Funds Linked to commodities Indexes

There are only two broad-based commodity indexes; ishares GSCI Commodity Index and Trust DB Commodity Index Tracking Fund. When researching these funds, an investor will find that they use futures, including collateral and yield interest loans, which charge the same expenses. There are some differences between the two funds. The first difference is that DB Commodity Index Tracking Fund only tracks six commodities while ishares GSCI Commodity Index Trust will track a more simplified  index of 24 components. Half of DBC is made up of energy, however, it accounts for over 75% of the benchmark and dominates ishares GSCI Index.

The roll strategies between the two indexes are another difference. DBC will look at 13 months for the highest yield, instead of rolling the expiring differences to the next month available. iShares, on the other hand, uses a five year contract, known as CERF kind of futures contract. The advantage to this is that CERF contracts will reduce trading costs.

While both funds will require taxes to be paid on their interest income, the GSCI Commodity Index fund are benefited with special long-term contracts where the annual tax can be dodged. It is important to mention that there is some controversy on this subject, however, the IRS has not issued their final ruling on its capabilities.

Exchange-Trade Funds Linked to Commodity Equities

Commodity-focused equities are considered a good investment for those who are looking for corporate upside or leverage. This type of fund is also high in oil exposure. It is important to remember that there is a high risk of corporate malfeasance, even though the fees are low with this type of investment.

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