NEW YORK (TheStreet) -- Managed futures offer investors exposure to commodities, but with a strategy designed to make money in up or down markets. Instead of only going long a commodity, these funds can take short positions as well, based on the rules guiding the underlying index. Over the long-term, this strategy can pay off.
An ETN that tracks a long/short commodity index:
ELEMENTS S&P CTI ETN
, or ELEMENTS Linked to the S&P Commodity Trends Indicator - Total Return. With an average of 80,000 shares trading per day, volume is adequate, but investors must weigh the credit risk of the issuer, HSBC USA. LSC has an expense ratio of 0.75%.
Since inception in June 2008, LSC is down about 17%, but
PowerShares DB Commodity
is down more than 50% and
iShares S&P GSCI Commodity-Indexed Trust
is down more than 60%.
The index tracked by LSC uses a moving exponential average to decide whether to go long or short in each sector. When the price is above the average, the index will go long the commodity, and when it is below, the index will go short. In the case of energy, the index will not go short due to potential upside volatility. Instead, energy's 37.5% weight in the index is spread "proportionately to the other five sectors" as the fund takes a neutral position.
The sectors are rebalanced monthly and the components within the sectors are rebalanced annually. As of the May 2010 rebalancing, LSC is long everything in its index except grains, industrial metals, coffee and sugar. Current weightings are 37.5% energy, 23% grains, 10% industrial metals 10.5% precious metals, 10% livestock, 3% in coffee, and 2% each in cocoa, cotton and sugar.
From February 2009 until May 2010, LSC lost about 20% while DBC and GSG gained about 20%. Since the system uses moving averages, it will tend to lag at crossover points, but do well as long-term trends unfold. Most of LSC's underperformance came in March, April and May of 2009 as commodities snapped back and rallied. It underperformed again in October 2009 as some commodities rallied strongly.
However, since May 2010, LSC is flat, while DBC is down more than 10% and GSG is down more than 15%. LSC's short positions in sugar and grains helped it outperform.
A similar index is tracked by
Rydex Managed Futures Strategy
. This fund charges a 1.99% expense ratio and includes a 1% redemption fee for shares held less than 30 days.
RYMFX tracks the S&P Diversified Trends Indicator. Half of this index is the same as the S&P CTI and follows the same rules; the other half comes from the S&P Financial Trends Indicator. All the weights are reduced by 50%. For example energy is 18.75%.
The other half of the index tracks financial futures made up of foreign currencies and U.S. Treasury bonds and notes. The weightings in the S&P DTI are as follows: 13% euro, 12% yen, 7.5% Treasury bonds, 7.5% Treasury notes, 5% British pound, 2% each in the Swiss Franc and Australian dollar, and 1% in the Canadian dollar.
According to S&P, the index is currently short all currencies except the Japanese yen, and long in the Treasury positions.
Year to date, RYMFX has outperformed the commodity-only LSC. Shares are down about 4%, thanks to the tumbling euro, which the index has been short on all year.
The way to use these funds is for long-term commodities and futures exposure. It doesn't make sense to always be long commodities, and these funds are likely to outperform over the long haul.
A mutual fund such as RYMFX makes more sense for conservative buy-and-hold investors who won't chase returns and have the patience to sit through periods of underperformance. With LSC, investors have to pay a bit more attention because if the banking situation ever turns ugly again, they'll need to make sure that HSBC is not among the problem banks.
-- Written by Don Dion in Williamstown, Mass.
At the time of publication, Dion Money Management was long Rydex Managed Futures Strategy.
Don Dion is president and founder of
, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years' experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.
Dion also is publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.