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New Commodities Fund Brings Sophistication

Stocks in this article: FTGC DBC

NEW YORK ( TheStreet) -- During the last decade, investors became more aware of the potential diversification benefits of investing in commodities thanks to repeated media appearances by investing legend Jim Rogers and a proliferation of exchange-traded funds offering access that didn't exist previously.

Recently, investing in commodities has fallen out of favor, but managers of the new First Trust Global Tactical Commodity Strategy Fund (FTGC) hope to rekindle interest in the asset class. FTGC is an actively managed fund, and First Trust is seeking to enhance returns compared with the other indexed commodity funds and to reduce volatility.

The fund will own between 10 and 35 different commodities. Commodities will be chosen based on the manager's "expectations for volatility based on historical data." Specific commodities will be chosen based on volatility and their correlation to other commodities. The fund will generally tilt toward lower volatility and low correlation.

Commodity fundamentals will come into play in choosing the specific futures contracts. Successful management of the "roll yield" can be a driver of returns. In the simplest of terms, if one contract expires at $50 and is replaced with a contract that costs $55, then that difference, called contango, will be a drag on returns. That happens in index funds that usually must buy whatever contract the prospectus calls for. The managers have discretion to choose the optimal contract to eliminate or at least minimize the consequence of contango.

For now, the fund owns 13 commodities. In agricultural commodities, the fund is heaviest in coffee at 11.5% of the fund, hogs 9.6% and soybean meal 9.1%. The total agriculture allocation is 50.3%.

Energy commodities make up almost 27% of the fund with West Texas Intermediate Crude being the largest holding in this group at 12.5% of the fund. Precious metals are the third group with a surprisingly small 17.1% weight in the fund.

Even more surprising is that silver is the largest holding in the metals tranche with a 7.4% weighting. Silver is typically much more volatile than gold. Silver, though, has a lower correlation to the other commodities than gold does, making it a better fit in the fund.

After a fantastic multiyear run into the financial crisis, commodities have generally floundered. The longstanding Power Shares DB Commodity Index Tracking Fund (DBC) is a good proxy for broad-based, indexed commodity investing. It started trading in early 2006 and rocketed to an 89% gain in just two years. DBC is down 43% from that high-water mark. It has generally traded in a narrow channel since bottoming out in 2009.

The overall strategy of investing in commodities is sophisticated and relies on a lot of moving parts coming together cohesively. Commodities do play a role in a diversified portfolio and FTGC could be the answer, but given the complexity, it would be reasonable for investors to give the fund a few months to build a track record before investing.

At the time of publication, the author held no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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