First Trust is probably best known for its lineup of AlphaDEX funds which seek to pick better stocks in a variety of countries or sectors. This ‘smart indexing’ approach has long been the mainstay of the company, and it is responsible for a huge chunk of the firm’s assets under management.
However, First Trust has also begun to branch out into various other, more active strategies as of late, pushing out products in the senior loan market (FTSL), and the managed futures space with their FMF fund. The trend isn’t stopping there though, as the company has just released its latest active fund, the Global Tactical Commodity Strategy Fund (FTGC).
This new fund takes a unique approach to commodity investing, looking to take a risk-managed approach to commodities that seeks to improve the risk/return relationship for the space. This is done by looking at several factors in the commodity futures market, any of which could help to differentiate this fund from others in the space (also see Inside the New iShares Commodity ETF).
FTGC in Focus
The advisor looks to maximize the return of a highly diversified commodity portfolio targeted to a specific volatility range. This is done by selecting between 10 and 35 distinct commodities, based on liquidity as measured by open interest.
These commodities' returns are then modeled, and the expected volatility is forecasted using daily historical data. Then, a set of portfolios that seeks to maximize returns given certain volatility levels are generated along the efficient frontier.
Commodities are then chosen to match this according to a desired risk range, though there is definitely a focus on stability, especially when compared to traditional portfolio construction approaches.
It is also worth noting that the fund managers will take into account several key aspects of the commodity futures contract process. The managers will consider the spot return, roll yield, and cash yield in order to select the best contracts and to roll to the correct ones that have the lowest roll cost, while earning solid income levels on assets held as collateral.
Additionally, the structure of the ETF is such that a K-1 will not be necessary at tax time. This can often be a pain for some investors, so it is worth noting that this fund will have 1099 tax form reporting.
At time of writing, this pushed the ETF into crude oil futures (March 2014) for 12.5% of the portfolio, Coffee Futures (July 2014) at 11.5% of the fund, and then natural gas futures (March 2014) for 11.1% of the ETF. Other top weights include lean hogs, soybean meal, and cotton #2, all of which receive at least 8% of the assets (see Two Soft Commodity ETFs Holding Firm).
Investors should note that the cost of this product is a little steep though, as it has an expense ratio of 95 basis points. Add this into likely low volumes out of the gate and investors may have a high total cost (when adding in a possibly wide bid ask spread), at least initially.
How does it fit in a portfolio?
Commodities could make sense for investors who believe that a growing global economy—and especially a surging market in the developing world—will increase demand for commodities (see all the top Ranked Commodity ETFs here).
This product in particular may be an interesting choice for those looking to go beyond ‘regular’ commodity ETFs that just roll from one month to the next, or those that just hold the same commodities month after month.
The product might not be a good choice for investors who anticipate a strong dollar or a slump in emerging markets, as either of these could definitely crush commodity-focused products. Additionally, this product is pretty pricey compared to some of its index-based competitors, so it might not be the top choice for cost conscious investors.
Competition and Bottom Line
There are well over 100 (unleveraged) commodity ETFs currently trading in the U.S., be they targeted plays on products like gold, or broad investments in a number of natural resources. While ‘traditional’ commodity ETFs like DBC and LSC look to be big competitors, USCI looks to be one of the most direct (see all the possible competitors in this list of Commodity ETFs).
This fund, which tracks the SummerHaven Dynamic Commodity Index, takes into account issues like backwardation and 12 month price change, and it selects from a wider basket of contracts (holding 14 of a possible 27). The product does charge 95 basis points as a management fee, while it has half a billion in AUM.
Still, FTGC has a unique approach and it could definitely attract some interest. However, the commodity ETF market is clearly very crowded, so it may be a difficult road initially for this fund, unless it can prove that its active technique is worth the cost to investors searching for a new commodity fund in today's rocky market.
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Read the analyst report on FTSL
Read the analyst report on FMF
Read the analyst report on FTGC
Read the analyst report on USCI
Read the analyst report on DBC
Read the analyst report on LSC
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