Investing in Commodities Intelligently: Question and Answer

Commodities can enhance portfolio diversification and provide access to global growth. Historically, commodities have also acted as a hedge against inflation, outperforming U.S. stocks and bonds. Even in periods of modest inflation (2-6%) commodities have historically outperformed U.S. stocks. This blog intends to answer frequently asked questions about the VanEck CM Commodity Index Fund and VanEck CMCI Commodity Strategy ETF, passively managed strategies that track the UBS Constant Maturity Commodity Index (CMCITR)¹. These funds offer “pure” commodity exposure by investing in commodity-linked derivative instruments and more conservative fixed income securities, such as short-term U.S. treasuries.

• How does the UBS Constant Maturity Commodity Index (CMCITR or the “Index”) represent exposure to commodities?
• What does roll yield mean?
• What are the benefits of the index’s “constant maturity”?
• How can investors access exposure to CMCITR?
• How do the VanEck funds gain exposure to the underlying commodity positions in order to track CMCITR?
• What is the tax treatment of the VanEck funds?
• How can investors buy VanEck’s Commodity Mutual Fund and ETFs?

How does the UBS Constant Maturity Commodity Index (CMCITR or the “Index”) represent exposure to commodities?

CMCITR represents 29 commodity components across five sectors: energy, agriculture, industrial metals, precious metals and livestock. The Index is designed to reflect the economic significance and market liquidity of each commodity as opposed to a traditional global production approach, which often results in significant energy commodity exposure.

The selection and weightings of the commodity components are reviewed annually in July when new target weights are set. The Index is rebalanced monthly to target weights throughout the remainder of the year.

The Index represents futures contracts tied to each commodity component with several maturities ranging from one month to three years, effectively spreading exposure to each commodity component along the futures curve.

What does roll yield mean?

Roll yield refers to the profit or loss that can be generated when investing in the futures market due to the price difference between futures contracts with different expiration dates. For example, when traditional commodity indices roll their future contracts from month to month, instances may occur where the next month’s futures contract is purchased for more than what expiring front-month futures contracts sold for. This creates a roll loss and results in “negative” roll yield. Roll yield is positive when a futures contract trades at a higher price than future dated contracts as it approaches expiration.

What are the benefits of the index’s “constant maturity”?

With CMCITR, the maturity of each commodity component remains fixed at a predefined time interval from the current date at all times. The “constant maturity” concept is achieved by a continuous rolling process, where a weighted percentage of contracts are swapped for longer-dated contracts on a daily basis. This procedure produces a more continuous form of “pure” commodity exposure and provides a better balance of forward price behavior than traditional commodity indices, such as the Bloomberg Commodity Index (BCOM) or the S&P GSCI (GSCI). Additionally, this feature of CMCITR can minimize exposure to the negative effects of roll yield, making the index more representative of the underlying market price movements.

To avoid the “contango trap” that occurs when front-month contracts approach expiration and must be sold below the purchase price of longer-dated contracts, CMCITR’s methodology expands the range of index components beyond short-dated contracts, resulting in increased diversification across a range of contract prices and expiration dates. Rather than roll all contracts within a monthly window of just a few predictable days, CMCITR employs a daily rolling mechanism. Each day, the index rolls a small portion of its futures contracts to longer-dated maturities, based on a rules-driven formula designed to capitalize on the most attractively priced longer-term contracts. This method has the potential to reduce negative roll yield in futures contracts that are in contango and enhance positive roll yield in contracts that are in backwardation. Monthly rebalancing of contracts back to target weights helps to avoid market-driven concentrations of assets in any given contract.

How can investors access exposure to CMCITR?

VanEck offers two investments to access the returns of CMCITR. The VanEck CM Commodity Index Fund has been available to investors since 2010 and allows for daily investment at the mutual fund’s net asset value and is offered in several share classes. VanEck also recently listed an exchange-traded fund (ETF), VanEck CMCI Commodity Strategy ETF (CMCI), that allows investors to access this intelligent approach to commodity investing throughout the day on exchange. Both funds seek to track, before fees and expenses, the performance of CMCITR.

How do the VanEck funds gain exposure to the underlying commodity positions in order to track CMCITR?

Because of the complexity of the Index, such as the daily roll process, it is currently more practical for the funds to gain exposure via a total return swap agreement than to invest in the Index’s individual futures contracts. The funds engage with UBS, currently the sole swap counterparty of the funds, and enter into swap agreements in which the funds receive the return of the Index in exchange for a fee to the swap provider. This arrangement can result in slightly higher tracking error relative to the Index than may occur when investing in futures contracts directly due to the fee associate with the total return swap.

What is the tax treatment of the VanEck funds?

The VanEck CM Commodity Index Fund and VanEck CMCI Commodity Strategy ETF provide access to commodities without burdensome K-1 tax reporting. In order to provide K-1 free exposure to commodities, the funds distribute of all their net investment income to shareholders as dividends annually, and distribute any net capital gains, at least annually, in December. These distributions are generally taxable as ordinary income or capital gains, unless being invested through a tax advantaged retirement account, such as a 401K or IRA, which if distributed, may be taxed as ordinary income when withdrawn. Years in which commodities perform well may result in larger income distributions from the funds than in years with muted performance. Please consult your tax professional to determine how these distributions affect your individual tax situation.