J.P. Morgan |

E-mail

Untitled Document Commodities-Futures ETFs

A Different Animal

Recent headlines about commodities ETFs-particularly the U.S. Natural Gas Fund (NYSE Arca: UNG)-have brought to light just how diverse the landscape of ETFs has become.

While the industry is fond of saying "ETFs are mutual funds with a twist," futures-based ETFs are nothing of the sort. Instead, they are organized as commodities pools (as is the case with UNG) or as trusts which in turn invest in a commodities pool (as is the case with the iShares S&P GSCI Commodity-Indexed Trust, NYSE Arca: GSG).

The commodity pool structure is quite different than the more common 1940 Act mutual fund structure underneath traditional ETFs. Perhaps most importantly, commodity pools and trusts aren't required to have independent boards, annual meetings or to solicit proxies.

For the most part, this tends to have little impact on investors. There is, however, one very good reason these products avoid the '40 Act umbrella: taxes. The IRS is very picky about where a 1940 Act fund generates its income and how it distributes it, and previous 1940 Act mutual funds ran into IRS trouble when using the swaps many commodities ETFs rely on for parts of their exposure.

Operationally, futures-based ETFs face substantial challenges. Most often designed to track the performance of either a single futures contract or a small basket, they must re-enter the markets to sell expiring contracts and repurchase their exposure every month, causing media and regulators to speculate about the market impact the largest, multibillion-dollar commodity ETFs may be having on prices. The CFTC has launched an investigation into this very issue, and we expect new guidance for ETF issuers to be forthcoming later this year.