NEW YORK (TheStreet) -- Investors interested in direct access to individual agricultural commodities were just given several more choices this week with the Teucrium Soybean Fund (SOYB) - Get Report, the Teucrium Wheat Fund (WEAT) - Get Report and the Teucrium Sugar Fund (CANE) - Get Report. Teucrium Trading first entered the arena a little over a year ago with the Teucrium Corn Fund (CORN) - Get Report which has attracted over $100 million in assets.
Similar to CORN, the new funds are futures-based which makes them susceptible to the vagaries of the futures curve, meaning that as futures expire they can sometimes be replaced with futures that cost more than the ones expiring. This is referred to as contango and can be a drag on returns.
In an effort to minimize the effect of contango the Teucrium family of funds staggers the expiration of the futures held. SOYB puts 35% in the second contract to expire, 30% in the third contract to expire and the remainder in the November contract that expires after the middle contract. WEAT has 35% in the second to expire, 30% in the third to expire and the rest in the following December. CANE has 35% in the second to expire, 30% in the third to expire and the rest in the following March contract.
While the above may seem difficult to process the big idea is that the funds avoid the about-to-expire contract and the manner in which they spread the maturities gives a reasonable chance of avoiding contango.
The funds will all charge a 1% expense ratio which may seem expensive on a nominal basis but the contango-busting strategy requires a lot of trading activity by the managers, beyond a typical stock fund that must rebalance quarterly.
That these funds are futures-based might be a source of frustration for some investors, but the only practical ways to access these commodities is a futures-based ETF or an exchange-traded note like the funds from iPath. Physically backed funds, like the
SPDR Gold Trust
would be prohibitively expensive because of how cheap agricultural commodities are in nominal terms. Also, things like wheat cannot be stored indefinitely like bars of gold; eventually the wheat would go bad either from age or possibly mold.
Derivatives-based funds have been getting a lot of negative attention in the media lately due to the trading scandal at UBS. The "rogue trader" story, despite the headlines, did not involve the malfunction of any ETFs. It was about a trader who lied about having hedges in place that were not actually in place. That being said, derivatives-based funds like these do take on the risk of their counter parties failing one way or another, either failing on the contracts or going out of business. This type of failure is not realistically probable but it is a possibility.
Exchange-traded notes are unsecured debt obligations of the issuer and so the risk there is that the issuer can no longer meet its obligation (in the face of default, note holders should expect nothing). Again, the likelihood of a failure after so much effort went into preventing these banks from failing in 2008 makes this a very low probability, but it is possible.
The tradeoff for buying commodities like wheat and sugar are the risks above. An investor who puts 2% to 3% into a fund that fails would be right to be upset, but they would be far from wiped out. Anyone for whom these remote risks are unacceptable should avoid the funds.
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At the time of publication, Nusbaum was long GLD, although positions may change at any time.
Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback;
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