Beware of Commodity ETFs

ETFs are often considered the Jazz song of investments.  Everyone says that they like them, but the masses don’t yet feel comfortable enough to with them to partake in them regularly.

The benefits of ETFs are widely known:  12b-1 fees and management fees are generally not charged to investors, and typically investors deal with fewer capital gains distributions annually versus traditional mutual funds.

Nevertheless, the underlying structure of an ETF may cause unexpected costs on the backend.  In particular, if the ETF is structured to facilitate investing in commodities.

As an advisor, I’ve investigated creating ETFs with art, gold and other hedges against the stock market and inflation.  The obvious benefit of investing in these via an ETF is the potential for greater diversification, as well as liquidity.

However, in order to hold commodities an ETF today is organized under different rules than a mutual fund, which are unable to directly invest in commodities.

ETFs not organized as RICs (e.g., Registered Investment Companies) are regulated under a different commission and may have an unexpected underlying structure — for example, a corporation or a partnership.

As a taxpayer, you may already know that structures like these may be taxed as pass-through or via other complicated or unexpected methods.  So while the typical pain points such as fees and capital gains may provide benefits over mutual fund investing, certain ETF characteristics may be unexpected by an investor who is used to holding mutual funds including the impact on tax preparation for holding an ETF that isn’t a RIC.

As with all things, seek the advice of an experienced advisor before wading into muddy waters and ultimately singing the blues.

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