Commodity funds hit a roadblock.
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This article originally appeared in Morningstar FundInvestor, an award-winning newsletter that presents investment strategies and tracks 500 funds.
Commodity prices have soared over the past several years, and several mutual funds that invest in commodity futures have rung up sizable gains. But a recent IRS ruling puts a crimp in the strategies of some of those funds. Here's our take on where each one stands.
PIMCO Commodity Real Return Strategy
Since its June 2002 inception, this fund has grown to a remarkable $12 billion, making it the largest of the group by far. Unfortunately, it's also the fund most directly affected by the IRS' action. It uses total return swaps (where it pays interest plus a small fee in exchange for the total return of an index) to gain full exposure to the Dow Jones-AIG Commodity Index. However, in December, the IRS ruled that the income from such swaps is not considered qualifying income; in order to retain its status as a registered investment company, at least 90% of a fund's income must be qualified. (That status confers favorable tax treatment.) The IRS has given this fund and others until June 30 to comply with its ruling.
PIMCO has yet to determine its course of action; it may turn to structured notes (which are used by two funds below) or pursue legislative remedies. If the fund is forced to comply, it may lose some of its performance edge. The swaps allow the fund to get full exposure to the index while also investing nearly all of its assets in Treasury Inflation-Protected Securities. It appears that using notes won't allow the fund to get commodity exposure quite as efficiently.
All told, we think shareholders have reason to hang on here, but we don't think investors should pay a commission for new shares until this issue is resolved. The fact that commodity prices may be due for a breather provides yet another reason to tread carefully here.
Oppenheimer Real Asset