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New commodity funds aimed at investors with a case of ‘nerves’

by Wayne Cheveldayoff, 2005-09-08

Are you getting worried about how long the commodity boom will last?

For those with a case of ‘nerves’, the financial engineers on Bay Street are offering two never-seen-before funds that will let you play commodities with no downside risk or diversify in the energy sector in a way that allows you to benefit even if energy prices head down.

One of the new RRSP-eligible funds is the Pro-Hedge Multi-Manager Energy Fund, which will tap several hedge-fund managers to play the long and short side of energy stocks and futures markets on your behalf.

The other is the Sentry Select Rogers International Commodity Index Principal-Protected Notes, which offer a chance to reap the gains of a commodity index with the guarantee that you will at least get back all of your original investment after eight years from the National Bank of Canada.

On a cautionary note, these are definitely not for everyone, and of course there are always substantial fees involved – higher than normal mutual fund fees – for the privilege of being involved.

Many investors may prefer to stick with direct share ownership or mutual funds investing in energy and mining companies, which have yielded outsized performance in the past few years.

But the boom for energy and other commodity prices has been going on for some time and no boom lasts forever. So the diversity or protections offered by the two new funds may appeal to those who are nervous but want to stay invested.

The Sentry Select Rogers International Commodity Index Principal-Protected Notes (offering memorandum available from www.sentryselect.com) are designed to track the commodity index created by hedge-fund legend Jim Rogers – a long-time commodities bull (see www.jimrogers.com).

The index was developed to be an effective measure of the price action of a basket of 35 different physical commodities traded on exchanges in five countries. Energy makes up 44% of the index but it includes other commodities ranging from sugar to rubber, live hogs, orange juice and raw silk.

The National Bank of Canada has guaranteed that investors will get back their initial investment if they stay with the notes for eight years. But anyone participating in the notes should know several things, including that any earnings paid out at maturity above the initial investment will be regarded as interest (not capital gains which are taxed at half the rate). There may not be a market for the notes if you want to sell before maturity, but if you do manage to sell, there are redemption fees starting at 3.5 per cent but dropping to nil after 24 months. And the management fees are substantial, at least 2.75 per cent a year plus costs for Canadian-dollar hedging and commodity transactions.

Because these are structured notes with a bank guarantee, investors with as little as $2,000 can purchase the notes.

On the other hand, the Pro-Hedge Multi-Manager Energy Fund is being offered to investors with at least $150,000 to invest in the fund or who qualify as “accredited” investors – generally individuals with $1 million in financial assets or with pre-tax income of at least $200,000 in the past two years (exact rules vary from province to province).

The offering is a fund of hedge funds (see www.pro-hedge.com) with the investment spread among a half-dozen energy savvy managers in Canada and the United States, with, of course, the usual management fees (at least 2.75 per cent annually plus 20 per cent of the profits).

The overall objective is to place the money with managers who can profit from the volatility – the downs as well as the ups – in energy prices in the coming years. Conventional mutual funds would only perform well during the ups.

One of the featured managers is veteran John Stephenson of Second Street Capital, who will take long and/or short positions in large-cap energy firms and utilities as well as commodity futures.

Other managers will play small and mid-cap (junior) exploration firms, energy (including weather) derivatives, small and large-cap U.S. energy firms, and U.S. energy infrastructure like pipelines (via U.S. master limited partnerships – similar to our royalty income trusts).

Pro-Hedge is the first out of the gate with an energy-oriented fund-of-hedge-funds offering. More are likely on the way.

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