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New and Improved Commodity ETNs?

If at first ETF investors don’t succeed investing in commodities the way Jim Rogers does, they can now try a different approach.

A new group of exhange-traded notes is designed to improve on an initial attempt to track commodity guru Jim Rogers’s international commodity indexes. After a two-week delay because of Hurricane Sandy, the five new “enhanced” ETNs based on Rogers’ RICI indexes opened for trading on the New York Stock Exchange’s NYSE Arca platform earlier this month.

Sponsored by the Royal Bank of Scotland (RBS), the group includes one broad-based, multicommodity ETN (RGRC), and four ETNs on specific segments: agriculture (RGRA); energy (RGRE); precious metals (RGRP); and industrial metals (RGRI). Each will be launched with $4 million in seed capital, says Tom Haines, RBS’s head of Northern American indexes and listed products, based in Stamford, Connecticut.

They’re not the first ETNs based on the RICI indexes to hit the U.S. market. Back in October 2007 Merrill Lynch, now a subsidiary of Bank of America, launched four ETNs based on Rogers’s indexes as part of its “Elements” series. Those ETNs, issued by the Swedish Export Credit Corporation (SEK), include one ETN for all of the metals (RJZ), which had $37.3 million in assets as of November 12. Other than that, it’s the same line-up, with a multicommodity ETN (RJI) with $625.7 million in assets; an agriculture ETN (RJA) with $381 million; and an energy ETN (RJN) with $67.8 million.

The returns on the original ETNs have been less than impressive, according to Merrill’s public documents. The RJI broad-based ETN has a five-year gain of 4.09 percent and a year-to-date loss of 0.47 percent as of November 12. The biggest gainer was the RJA agriculture ETN with a five-year gain of 6.35 percent and a year-to-date gain of 2.57 percent; the biggest loser was the RJN energy ETN with a five-year gain of just 0.43 percent and a year-to-date loss of 8.70 percent; and the RJZ metals ETN had a five-year gain of 4.60 percent and a year-to-date gain of 2.22 percent.

So why should anyone get excited about another series of ETNs based on Jim Rogers’s indexes? Because RBS believes that they’ve come up with a series that can do better.

The original RICI index that Merrill’s ETNs follow is structured so that Merrill is required to consistently reinvest in front-month futures contracts.

The problem with being locked in to buying that contract is the phenomenon known as contango, which occurs when the near-month futures contract is cheaper than those expiring further out into the future. If the market is in contango, as the ETN rolls its expiring contracts, it has to sell low and buy at a higher price.

“If the commodity has been in steep contango, the negative roll yield can significantly eat away at the fund’s returns over time,” says Dennis Hudachek, an analyst at IndexUniverse in San Francisco.

But the front-month rolling strategy has its benefits as well, says Trent Stout, the head of global commodity index and products at Bank of America Merrill Lynch in Houston. Sometimes, the market is in backwardation — the opposite of contango — and that’s favorable to investors, Stout notes. But also, “it’s a very transparent strategy, so you know exactly what you’re getting,” he says.

Perhaps. But Haines says RBS’s “enhanced RICI” indexes will operate under a different formula that will take other factors into consideration: the liquidity of particular futures contracts and the seasonality of specific commodities. They will also consider what’s called “term structure,” which is the curve of the futures market, whether up or down, Haines says.

RBS introduced its Enhanced RICI ETNs in Europe about five years ago, and in Australia in 2011, Haines says. He says his corporate counsel won’t let him discuss the returns on investment products that aren’t registered in the U.S., but that the five-year return on the Enhanced RICI Total Return index through October 2012 was 4.22 percent versus a negative 15.03 percent on the original RICI Total Return index.

RBS’s five “enhanced RICI” ETNs will be sold as part of the bank’s “Trendpilot” line of ETNs, but will be different in that they will be “buy and hold” products, Haines says, noting that the other Trendpilot ETNs are unique in that they can go to all cash when certain limits are triggered. (Overseas, the product is known as the “Autopilot” line.)

Jim Rogers, reached in Chicago, where he was giving a speech, says that he’s been working with RBS for “at least eight years.” The enhanced RICI indexes have been “successful in the rest of the world,” he says, so RBS “made the decision to bring them to the U.S.”

Rogers says there have been “essentially no changes in the weights in my indexes since the beginning,” back in 1998. He says he believes that when it comes to global consumption, energy is the most important category — “extremely important to all of us,” he says — followed by agriculture, and “metals is third,” he says.

“Most indexes, you have no idea what you’re buying because they change them all the time,” Rogers says. “To me, as an investor, I want transparency, consistency and stability, so I know what I’m investing in,” he says, by way of explaining why he so rarely reweights. “If we found out that cotton causes cancer, obviously we would meet and take it out of the index, or if we found out that orange juice cures cancer, we would have to increase the weighting,” he says, noting that his investment committee meets formally every December, but there “have been very few changes since 1998.”

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