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By Paul Justice, CFA | 08-11-2010 03:52 PM

A Smarter Commodity ETF

The USCI Fund offers individuals a new, and possibly better, approach to access the commodity market but risks remain, according to Morningstar's Ben Johnson.

Paul Justice: Hi, there. I am Paul Justice, Director of North American ETF Research at Morningstar. Today, I'm here to talk to you about the ever evolving landscape of commodity ETFs, whether it be the proliferation of products or the evolution of the strategies in which they employ. I'm joined today by Ben Johnson, one of our ETF analysts.

Thank you for joining me, Ben.

Ben Johnson: Thanks for having me, Paul.

Justice: Well, we saw an interesting product that was just launched this week that really throws a wrench into the commodity landscape as far as recognizing these horrible returns investors have gotten from contango effects, which is fairly complicated matter that people need to understand when they're buying these ETFs in the first place. But people still focus on the fact that they want to have commodities in their portfolios to diversify or an inflation hedge. Could you talk a little bit about the methodology of this fund and why it actually addresses some of the issues that are pending on the market today?

Johnson: Sure. So, again the problem that's plagued a lot of long-only commodity futures strategies is, as you stated contango. So when I look at the futures curve for say, oil, current futures prices are lower relative to futures prices further out along the curve. So every month those long-only futures strategies are being forced to sell a relatively low priced futures contract, and then roll into or buy a relatively high priced futures contract.

Justice: That's relative to the price that it should be in a natural market…

Johnson: Correct.

Justice: – as far as cost of storage and everything else, and we had seen this persisting for the last five years.

Johnson: Correct. Contango has been persistent across the majority of commodity futures markets, so obviously this has been eating into the returns of long-only futures strategies and in turn, the ETFs that invest in those strategies.

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