ETF Wrap: Beans in the teens, and the taxman helpeth?

Yet markets and financial services do evolve, and today’s Wrap is a microcosm of everything that’s made the ETF the financial product of the 21^st century. We talked to Todd Rosenbluth of CFRA about tax efficiency, and to Sal Gilbertie about putting corn and soybeans into an ETF.

Gilbertie told us he started his ETF company because he wanted to offer ordinary investors access to agriculture futures, just like institutional investors. Rosenbluth mused that if ETFs had somehow come first, mutual funds would likely never have existed.

ETFs are what happens when financial services and products are designed for end investors, not asset managers.

Things will keep evolving, of course, most likely in ways we can’t even imagine. After all, ETFs were born out of the 1987 market crash. Markets could never drop 22% in a single day now, of course: not just because of circuit breakers but because we’ve come up with new ways of responding to market shocks.

And maybe that’s just the point.

Stay tuned — and thanks for reading.

Even more ETF-ication of everything?

The suggestion last week that President Joe Biden might raise the capital-gains tax briefly dented risk assets –– but it also offered some good news for the ETF industry. Since ETFs are by their nature more tax-efficient than mutual funds, a higher tax regime might lead to mutual fund investors seeking out ETFs instead, many observers think.

As a reminder, when investors in an ETF sell their shares, the trading that needs to happen to free up cash for that investor usually takes place between market makers. That keeps other shareholders shielded from capital gains implications. In mutual funds, however, the fund manager must buy and sell shares held by the fund, meaning that investors who hold shares of the fund during the year may be subject to a tax event because of another shareholder’s redemption.

There’s little data on the exact numbers for each of those two situations, but as CFRA’s Todd Rosenbluth put it, “It is relatively rare for an equity ETF to incur a capital gain for existing shareholders and it’s common for peer mutual funds to do so.” (Here is an analysis from Morningstar on the topic.)

In fact, according to an analysis from Rosenbluth, ETFs from the biggest fund providers — iShares, Invesco, Schwab, State Street Global Advisors and Vanguard — make up 88% of all ETF assets. Among nearly 600 of those companies’ equity funds, only three ETFs had capital gains distributions for investors last year.

If capital gains do become more restrictive, some investors might leave mutual funds for ETFs, Rosenbluth thinks. And more mutual fund managers may transition their existing products into ETFs, as some firms have just started to do, to avoid losing customers.

“Given all the benefits of ETFs — tax efficiency, liquidity, accessibility and the way that they’ve brought costs down, if ETFs existed 50 years ago, we never would have seen mutual funds,” Rosenbluth told MarketWatch. “ETFs are built for the environment we’re in today where investors are more in charge of their financial goals and where more money is going into their bottom line and less to the manager.”

There’s a lot of inertia keeping money in mutual funds, Rosenbluth acknowledged, including the huge amounts of money invested in defined-contribution plans, in which the benefits that differentiate ETFs from mutual funds aren’t as significant.

Still, he said, inertia changes when there’s a catalyst, and tax-law changes may provide exactly that spark.

Exchange-traded sundries

What do you get when you combine two of the most popular investing themes? S&P Dow Jones has rolled out five new Dividend Aristocrats Indices with environmental, social and governance (ESG) criteria. The new indexes cover developed markets, high yield, global markets, quality income and euro-area high yield.

A new artificial intelligence-powered ETF is taking another crack at the value nut by prioritizing intangible assets like intellectual property, brand power and leadership. That results in an eclectic portfolio with stocks like CVS Health, CVS, +0.95% FedEx Corp, FDX, +2.00% and GameStop Corp. GME, -3.09% The Qraft AI-Enhanced U.S. Next Value ETF NVQ, -0.61% has picked up just under $5 million since launching in December, and charges 75 basis points. It’s returned 20.4% in the year to date, vs. 11.4% for the S&P 500.

Is there an ETF for that?

Beans are in the teens, the price of corn is airborne, and the continuous contract for wheat W00, +0.93% cannot be beat.

Agricultural commodities are on a tear, in other words. There may be some good reasons for investors to add exposure to the sector using ETFs.

While many investors have exposure to gold or oil, agriculture holdings are less common, said Sal Gilbertie in a MarketWatch interview. Agriculture doesn’t correlate well with more widely-held asset classes, Gilbertie says, yet it can be much more of an all-weather diversifier since it’s so “pervasive,” in his words. “It doesn’t matter what the economy is doing, who the president is, what the latest iPhone looks like,” he said.

Gilbertie has had a long career in financial services, including creating the first ethanol swap nearly two decades ago. He founded Teucrium, an ETF company that now runs five funds, because he “couldn’t believe there was no exposure for ordinary people,” who aren’t able to trade commodities futures.

A growing human population and a rising middle class makes the demographic tailwinds unbeatable, he argues.

Corn, for example, is used for everything from feeding livestock to feeding humans, fabricating the starch that goes into products like paper and ink, fueling our vehicles, and developing industrial products like adhesives and lubricants.

Prices for corn futures bounced near breakeven for the past several years as weather stayed supportive. But since late last year, conditions have shifted and prices rose — soybeans cracked above the psychologically important $13 benchmark on Dec. 31 and haven’t looked back. Poor weather in the Southern hemisphere has limited supply of some commodities, and demand has surged as economies begin to reopen.

It’s possible that investors missed the most recent rally in corn and other ag products, Gilbertie acknowledged. “It’s going to be hard to have another leg up that’s this big,” he said. Still, he sticks to his belief that “investors need to consider grains. As Peter Lynch said, trade what you know.”

Teucrium offers four crop-specific ETFs, tracking prices for corn CORN, -0.06%, wheat WEAT, +1.23%, soybeans SOYB, +0.12% and sugar CANE, -1.23%, and one that aggregates the four TAGS, +0.28%. They were the first of their kind, launching over a decade ago, and have assets ranging from $183 million, in CORN, to $17 million for CANE.

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