UBS' New Commodity ETNs Could Be Overkill

Last week, UBS listed eight commodity-related ETNs under the brand name E-TRACS.

I am hard-pressed to think another gold or silver exchange-traded product is needed on the U.S. market. "Me-too" products, whether they are for equities, currencies or commodities, will struggle to attract assets. The other six products offer the chance at some differentiation.

The new ETNs are:

UBS Bloomberg CMCI Gold(UBZ Quote)

UBS Bloomberg CMCI Silver(USV Quote)

UBS Bloomberg CMCI Index(UCI Quote)

UBS Bloomberg CMCI Industrial Metal(UBM Quote)

UBS Bloomberg CMCI Energy(UBN Quote)

UBS Bloomberg CMCI Livestock(UBC Quote)

UBS Bloomberg CMCI Food(FUD Quote)

UBS Bloomberg CMCI Agriculture(UAG Quote)

The broad-based UCI, according to the E-TRACS Web site, has dramatically outperformed (in the back test) the indices that underlie other broad-based exchange-traded commodity products, such as iShares S&P GSCI Commodity-Indexed(GSG Quote), and done so with much less volatility.

The industrial metals fund, UBM, has also outperformed its competitors, but by a smaller margin and with similar volatility. This fund is heaviest in copper, at 40.72%. The last few years have been a great time to own copper, and anything that hurts copper in the future will hurt this fund as well.

The energy fund is the same story of outperformance with less volatility vs. other energy funds that own oil, gasoline, natural gas and heating oil. In looking at the mix, there is no obvious reason I can see for the superior result.

The livestock fund is also better, and also less volatile. UBC is 58.06% cattle and 41.94% hogs. The similar iPath DJ AIG Livestock Sub Index(COW Quote) is 64.1% cattle and 35.9% hogs. Somehow that seemingly slight difference has accounted for UBC beating COW by 8% annualized for 10 years, according to the UBS site.

The food ETN is a broad mix of things like sugar, wheat, coffee and orange juice; again, it has better returns and lower volatility than any index they compare to. The mix of exposures in this fund is very appealing and the ticker symbol, FUD, is a winner.

UAG is very similar to FUD, except FUD includes small weighting to cattle and hogs while UAG omits those two. You probably guessed that UAG has better results with less volatility than other comparable indices.

The indices are all backtested for 10 years, but were actually created a little over a year ago. That all six (actually all eight because this applies to the gold and silver funds too) outperformed the competition in their respective backtests, most of them with less volatility, is a tad suspicious -- but there is information available about the methodology.

The funds are weighted based on something called Economic Weight, which is gleaned from CPI, PPI and GDP data. Then a screen for liquidity of the contracts mimicked is performed to create the Tradable Economic Weight, which ultimately determines the allocations of the funds.

It sounds complicated, and I am not sure if it will continue to yield better results in the future, but this is a point of differentiation from other funds and it has worked very well in the back test.

ETNs are debt instruments of the issuer, in this case UBS. None of the ETNs will pay interest, and they charge a 0.65% expense ratio.

Again, these are debt obligations of UBS -- the same UBS that recently made news for $37 billion in writedowns. The bank has had a lot of negative attention of late, including a lengthy writeup in The New York Times this past weekend. The chance that the bank could go under is quite low, but if there were to be a ratings downgrade as a result of the writedowns, the prices of the ETNs could be affected -- so says the prospectus.

One last, bigger-picture point is that there have been a lot of exchange-traded vehicles created, with more on the way, to invest in the commodity space. Wall Street does this over and over when something "new" comes along and is popular. It was the case with the Internet bubble, Chinese stocks and more.

As demand builds, more supply of investment products is created (with the Internet it was IPOs; with commodities it is ETFs and ETNs). Eventually, supply exceeds demand, which is a negative for prices.

It may or may not be more important than any of the positives, but it is a negative nonetheless.