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New combo fund provides exposure to commodity index along with monthly income for investors

by Wayne Cheveldayoff, 2005-06-23

The investment chefs on Bay Street have come up with a new culinary delight for those Canadian investors who want to savour the commodities boom but still want monthly income.

The new all-in-one meal, the first of its kind, is the Sentry Select Commodities Income Trust, which is currently being distributed by Sentry Select Capital Corp. via advisors and planners (prospectus available at www.sedar.com). The fund will trade on the Toronto Stock Exchange.

The new fund is being launched only a few weeks after another Toronto-based firm, Vengrowth Asset Management, introduced the first pure commodities fund for Canadian investors, the Criterion Dow Jones-AIG Commodity Index Fund (TSX: CDJ.UN). The Criterion fund’s return is linked directly and fully to the Dow Jones-AIG Commodity Index.

By contrast, the new Sentry Select fund is linked only in part to the performance of another commodity index, namely the Rogers International Commodities Index, which was created by hedge-fund legend Jim Rogers – a long-time commodities bull (see www.jimrogers.com).

Rogers is considered a commodities guru by the media, which gives widespread attention to his views and his index.

The Sentry Select fund is the first in Canada to offer exposure to the Rogers index.

The new fund will be constructed to initially provide approximately 25 per cent exposure to the commodities that make up the Rogers index and approximately 75 per cent exposure to a portfolio of commodity related income funds managed by Sentry Select.

The monthly cash distributions are expected to initially yield 6.75 per cent per annum.

One of the advantages of an investment in commodities, as the prospectus points out, is diversification and a reduction overall of portfolio risk.

Studies have shown that commodities have historically been positively correlated to inflation and not correlated to equity and bond returns.

However, while there is the opportunity for capital appreciation, the opposite could also happen. If commodities go into a slump, investors could easily end up with losses and a lower yield.

In short, if you don’t share Sentry Select’s and Jim Roger’s belief that the commodities boom will continue, it doesn’t make much sense – even if it provides good textbook diversification – to get involve in an investment linked to commodities.

The fundamentals – high demand, low inventories, lagging production – remain strong for most commodities and odds are that the boom will continue, but there is no guarantee.

The Rogers International Commodities Index has a heavy 43-per-cent weighting in energy products (crude oil, heating oil, unleaded gasoline and natural gas) but also contains 30 other commodities traded on exchanges and widely employed in the global economy.

These include grains, live cattle and hogs, lumber, cotton, base metals, coffee, sugar, cocoa, orange juice, wool, rubber, azuki beans, raw silk, palladium, platinum, gold and silver.

Many of these commodities trade in U.S. dollars and Sentry Select intends to hedge at least 90 per cent of the non-Canadian dollar currency risk.

The performance of the Rogers index from January 1 to May 27 this year was 7.13 per cent, according to the prospectus. The one-year index return was 11 per cent, three-year 102.36 per cent and five-year 97.11 per cent.

Of course, financial engineering doesn’t come cheap. The annual management expense ratio (MER) is likely to be around 2.25 per cent, including 0.4 per cent as a trailer fee to the selling broker, which also gets a 5 per cent commission for making the sale.

This commission and another maximum 1.5 per cent in expenses, for a total of 6.5 per cent, come off the top before the money is invested, so the net asset value in the first while is likely, as it usually is for funds of this kind, to be below the issue price of $10 per unit until the investment returns build up sufficiently to take it higher.

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