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Vengrowth launches first commodity index fund for Canadian investors

by Wayne Cheveldayoff, 2005-04-21

If you’ve been thinking about investing in commodities in your RRSP, you may want to take a close look at a new commodity index fund being launched this month.

The fund, which will track the price performance of a well-known basket of commodities, is the first of its kind for individual investors in Canada.

Until now, investors interested in commodities have either had to set up margin accounts to play commodity futures – something prohibitive or too complicated for most – or invest in the stocks of companies producing the commodities.

The fund, which is called the Criterion Dow Jones-AIG Commodity Index Fund, is being offered through a syndicate of 13 investment dealers by Criterion Investments, a subsidiary of Vengrowth Asset Management.

The company has filed a prospectus (available at www.sedar.com) for an initial public offering of trust units, which are intended to be listed on the TSX and eligible as Canadian content for registered investments like RRSPs.

The returns of the new fund will be linked to the Dow Jones-AIG Commodity Index total return. The index comprises 19 commodities traded on North American futures exchanges.

The index produced a total return of 9.41 per cent in the 12 months ended March 31 and annualized returns of 19.32 per cent in the past three years and 13.33 per cent in the last five years.

The basket of commodities is heavily weighted to energy, with crude oil, natural gas, heating oil and unleaded gasoline accounting for 36.2 per cent of the index.

This actually would be a positive feature for those expecting, as many experts are predicting, several years of strong energy prices as worldwide demand continues to push higher while supplies have a hard time keeping up.

The other commodities in the index (with weightings in brackets) include soybeans (7.86 per cent), aluminium (6.77 per cent), copper (5.65 per cent), gold (5.37 per cent), corn (5.32 per cent), live cattle (5.21 per cent), wheat (4.59 per cent), lean hogs (4.03 per cent), coffee (3.47 per cent), cotton (3.28 per cent), soybean oil (2.66 per cent), zinc (2.65 per cent), nickel (2.54 per cent), sugar (2.49 per cent) and silver (1.95 per cent).

A quarterly cash distribution of $0.1125 per unit is planned for the first year, representing a yield of 3 per cent per annum on a $15 issue price, but subsequent distributions will depend on the performance of the fund.

The distributions are advertised as “tax efficient” because they will consist of a combination of capital gains and/or return of capital – both of which are taxed at half of the income tax rate applicable to interest or business income.

There is nothing stable about commodity prices. Volatility can be dramatic, even for a wide-ranging basket of commodities. The Dow Jones–AIG index has been steadily climbing in recent years, but in a two year period, from March 1997 to February 1999, it swung from 126.85 to 74.24 before recovering. Details of the index and its performance are available at www.djindexes.com.

Vengrowth makes the point in the prospectus that studies have shown that commodities “have historically been positively correlated to inflation and negatively correlated to bond and equity returns.”

Thus, commodities improve the diversification of your portfolio, as they perform well when stocks and bond don’t.

But timing is everything in investing, and it still boils down to having to take a view on the commodity cycle. A number of analysts are predicting strong commodity pricing for years to come and you have to definitely buy into this outlook to get involved in commodities at this time after they’ve already had a good run.

As with all funds, there are costs for professional management and these are pretty much in line with other funds.

The management expense ratio likely will be around 2 per cent per annum, with 0.5 per cent going to Vengrowth, 0.4 per cent as a trailer fee to the selling advisor, and about 1 per cent to a counterparty for the forward agreement that swaps the returns on the fund’s actual investment in Canadian equities for the return on the Dow Jones–AIG Commodity Index. The selling advisor also gets a 5 per cent commission up front.

Wayne Cheveldayoff is a former investment advisor and professional financial planner. He is currently specializing in financial communications and investor relations at Wertheim + Co. in Toronto. His columns are archived at www.smartinvesting.ca and he can be contacted at wcheveldayoff@yahoo.ca.



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©2005 Wayne Cheveldayoff