Commodity ETF Rebuilt

Increased commodity regulation is forcing ETF issuers to find loopholes to keep their strategies alive. The latest funds to reconfigure are Deutsche Bank's(DB Quote) PowerShares DB Agriculture(DBA Quote) and PowerShares DB Commodity(DBC Quote) ETFs.
Rather than shutting down DBA, in the same fashion in which it shuttered giant PowerShares DB Crude Oil Double Long ETN in September, PowerShares will join the list of ETF issuers that are finding creative ways around commodities restrictions.

In order to satisfy the new "safety position limits" set by the Commodity Futures Trading Commission, $3.3 billion DBC and $2.2 billion DBA will reduce positions in corn and wheat futures by the end of October. In addition to enforcing the new limits, the CFTC has revoked an exemption that previously allowed DB ETF products to exceed position limits on agricultural products.

Like other popular commodities ETFs, including United States Oil(USO Quote) and United States Natural Gas(UNG Quote), DBA and DBC invest in commodities futures in order to achieve their tracking strategies. The bigger the ETFs grow, the more futures ETF managers buy.

CFTC hearings in recent months have made it increasingly clear that increased position limits would be placed on futures-based commodity ETFs. In response to looming regulatory changes, ETF managers have variously halted creation of new shares, shut down funds and restructured their underlying investment strategies.

The latest move by PowerShares will be a restructuring. DB has announced that in addition to reducing its holdings in corn, wheat, crude oil and sugar, it would be adding coffee, cocoa, live cattle, copper, natural gas and gasoline. Adding new commodities to the fund will reallocate assets and allow the fund to continue to function within position limits.


In addition to asset reallocation, DBC will also begin investing in Brent crude, an oilfutures contract traded in Europe. This loophole will allow the fund to reduce its U.S.-regulated oil holdings to 12.4% from 35% while adding Brent crude, gasoline and natural which will account for 12.4%, 12.4% and 5.5%, respectively.
As regulations hit futures traded on the New York Mercantile Exchange, fund issuers like PowerShares and United States Commodity Funds will simply reallocate assets to arenas that have different regulations. DBC's decision to cut down on Nymex-listed oil and buy Brent crude is a excellent example of this transition.

The threat of similar restrictions also has caused the mangers of UNG to cut back on natural gas futures contracts listed in the Nymex in favor of swaps that trade elsewhere.

Where there is a will, there is a way, and commodity ETF providers will continue to find ways to keep their funds running, even if it means riskier options for investors. Uncertainty is perhaps the greatest risk that futures-based commodity ETF investors face. Avoid these funds until the regulatory showdown has reached a resolution.