Thursday, October 19, 2017

New-to-Market: GraniteShares COMB & COMG

Thursday, October 19, 2017 - New-to-Market:  This blog series highlights ETFs that have recently gone public and reflect those strategies currently most in demand by investors. While ETFs are not eligible for ETFG Risk Ratings until traded for 3 months and ETFG Reward Ratings for 12 months, our goal is to highlight cutting-edge investment strategies that have recently embraced the ETF structure – we hope you enjoy this special series of posts!

Something we’ve frequently talked about over the years is how the explosion of investor interest in Exchange-Traded-Products has resulted in many newly launched funds simply being attempts at “building better mousetraps” for whichever sector or investment theme is in demand this month.  Whether it’s a momentum fund with quarterly reconstitution instead of semiannual or an equity income fund that weights by dividends instead of market cap, all these tweaks in the end add up to a fund that’s more “evolutionary” than “revolutionary” and which is one reason why we get so excited for the truly novel, new fund. The only thing more exciting than an innovative new fund is whether a fund sponsor takes the risk to a bring a new product to a challenging sector. If there’s any sector held in less regard than commodities, we haven’t found it. So for this edition of our “New-to-Market” series, we focus on a pair of funds from GraniteShares, a new player in the commodities sector and which we think could herald a major rethink for all commodity funds going forward.

We could dwell on how commodities have to be the least loved sector of the investment universe, but a quick glance at the performance of one of the largest commodity ETPs, the iShares S&P GSCI Commodity-Indexed Trust (GSG), since the start of the equity bull market, would tell us all we need to know. Linked to the S&P GSCI Commodity Index, GSG last outperformed the S&P 500 in 2007 and since then has been nothing but disappointment for buy-and-hold investors as the fund has racked up a trailing five-year return ending September 30th of -15.11% compared to a -14.38% for the S&P GSCI and a positive 14.22% for the S&P 500. Although major commodity indices enjoyed a strong 2016, that weak long-term performance has led to serious asset outflows resulting in only a handful of specialized product launches over the past few years and little to no analyst coverage as even heavyweight Morningstar no longer has analyst coverage on any ETPs in that space.

If you’re shocked that a new ETF issuer would pick such a downtrodden sector for its first funds, wait until you hear what sort of products they’ve brought to market.  In a time when new ETPs rely on such intricate strategies that their names require at least three lines and two commas, GraniteShares has chosen to go back to the basics by introducing not one, but two, broad-based commodity funds, the GraniteShares Bloomberg Commodity Broad Strategy No K-1 ETF (COMB) and GraniteShares S&P GSCI Commodity Broad Strategy No K-1 ETF (COMG). That’s right, instead of developing a niche strategy investing in specific commodities while relying on some long/short momentum strategy, GraniteShares has decided to go back to the basics by offering products focused on large and small investors who are looking for broad exposure to the asset class, with familiar reference indices and at a reasonable cost and hey, why not solve one of the biggest headaches with investing in commodities while you’re at it?

As their names imply, COMB and COMG offer not just broad exposure at a reasonable price (more on that later) but do so without generating an additional K-1 form investors need to keep track of for when tax season rolls around. The promise of ETPs was always that they offered a cheaper and more direct means to invest in different themes or asset classes, but the fact is that most commodity funds were structured as limited partnerships, requiring fund sponsors to send out a K-1 to every holder of the fund.  While that did allow them to directly own futures contracts, it has proven a major inconvenience for smaller investors and offered another reason to overlook the sector. The mechanics of how it does it is relatively straightforward; both COMB & COMG are ‘40 Act’ funds but instead of directly holding futures contracts, they instead invest up to 25% of their assets in a Cayman Islands subsidiary that will provide the commodity exposure through futures while the remainder of the fund’s assets are invested in variety of short-term Treasury bonds with a maturity of up to 2 years. Another benefit of “40 Act” funds is that they have a Board of Directors who represent the interests of the fund shareholders, something those commodity ETPs, structured as partnerships or ETNs, do not have and making it potentially easier to do things like raise management fees as the PowerShares DB Commodity Index Tracking Fund (DBC) has done in the past.

That work around allows more straightforward tax reporting for those looking at a more long-term play and an increasing number of fund sponsors are taking the same approach for new product offerings.  In fact, GraniteShares wasn’t the first group to offer K-1 free funds, an honor belonging to the First Trust Global Tactical Commodity Strategy Fund (FTGC), an actively managed product that adjusts its positions to achieve a target volatility. Although others were quick to understand the opportunities opened up by the K-1 free structure, ProShares Advisors offered its first K-1 free fund, the ProShares K-1 Free Crude Oil Strategy ETF (OILK), in September of 2016 while PowerShares filed a prospectus last fall in preparation to roll out three single-commodity strategies and ETF Securities has also moved into the space with passive benchmark replication.

If you’re wondering how GraniteShares sees itself standing out from the crowd, it’s by focusing on those long-term investors looking for the low-cost solution in a space where even passive strategies often charge relatively high fees. Expense ratios in the commodity space remain relatively high compared to other sectors and many of the most well-known funds in this space are also the oldest names with high legacy fees like the DBC charging .89% or GSG at .75%, comparable to what some newer, actively managed strategies in the space will charge. Investors looking for the lowest cost way to invest with the two most widely tracked commodity benchmarks should love that COMB and COMG carry management fees of just .25% and .35% respectively, something made possible by relying on an in-house portfolio management team instead of outsourcing to third party providers like other firms. That focus on keeping costs to a minimum should result in something important to index trackers everywhere, very low tracking error to their benchmarks, which along with avoiding the K-1 hassles, should make these two funds an easy pick for any investor’s shortlist.

While ultimately the commodities sector still has a long way to go before it can make its way back into the hearts of asset allocators, and more important their portfolio’s, GraniteShares is betting that the commodity bear market is behind us and that now is the time to bring some of passive investing’s best practices to the commodity space. Nevertheless, we think the rise of “no K-1” funds offering easy and cheap exposure to the sector is sure to catch the attention of more fund sponsors and lead to a new attitude towards product development going forward. Whether evolutionary or revolutionary, that’s still something about which to get excited.

Thank you for reading the ETF Global Perspectives.

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