GSP - BCM: This Unconventional Exposure To Commodities Works

2023-04-04 13:03:16 ET

Summary

• BCM is an ETN that offers exposure to the commodity markets via replicating the performance of Barclays Commodity Index Pure Beta TR.
• As a debt instrument, BCM eliminates tracking errors and can offer tax advantages to long-term investors.
• ETFs are more suitable for speculating on commodity prices, but BCM has the potential to deliver stronger returns over the long haul.
• BCM's fees are high when compared to commodity ETFs, but not unreasonably so.
• The call risk of BCM, which is unusual for an ETF investor, will naturally cause discomfort, but based on Barclays' ETN call record, I don't think it is high.

Thesis

The iPath Pure Beta Broad Commodity ETN (BCM) is not as popular as ETFs that offer exposure to the commodity markets. Its market capitalization is comparatively small and there's not much coverage for it. I think that this is because of its structure as an ETN, which is definitely not the norm for either passive or active investors.

With that being said, I believe BCM is a superior choice to commodity ETFs. Its structure, the very reason that could be making it unattractive to investors, offers a great advantage here. Both the tax benefit inherent in ETNs and the elimination of the tracking error has the potential to yield better returns than an ETF can.

I also think it's the best choice among the other commodity ETNs issued by Barclays. Its past price performance, even though it failed to match the index, looks better than that of both commodity ETNs and ETFs.

In this context, the fees are reasonable for BCM and the call risk, which is not a great cause for concern, is worth it.

Understanding BCM

BCM was issued by Barclays Bank PLC on 18 April, 2011 and is listed on NYSE Arca under the ticker "BCM". It currently has a market capitalization of approximately $40 million.

As an unsecured debt obligation, BCM is supposed to reflect any change in the price of Barclays Commodity Index Pure Beta TR when it matures on 18 April, 2041. This index was launched on 1 February, 2011, as a way to represent the performance of the commodity markets by tracking futures contracts on commodities.

Since ETNs (Exchange-Trade Notes) are disproportionally fewer than ETFs out there and, therefore, much less familiar, I will have to take a moment to explain these securities.

In essence, an ETN is an unsecured senior debt security issued by a bank that promises to pay the difference in the price of an index from the time of purchase to the maturity date, less the fees charged. Although the bank will trade securities to match the performance of the index, its performance will not affect the performance of the ETN; the bank will still have to pay you the difference in price at maturity even if it failed to match the index.

As a direct consequence of this characteristic, ETNs eliminate what is known as tracking error, a common concern for ETFs. However, this "elimination" is only certain at maturity. The issuer of the ETN is not obligated to redeem and issue notes and may suspend such activities at times. Additionally, the credit rating of the issuer may be impaired. Therefore, there's a chance that the performance of the ETN will significantly deviate from that of the index during certain periods before maturity, which makes ETNs unfit for speculators.

Besides the elimination of tracking error, ETNs also provide a better tax treatment than ETFs. Since there won't be an underlying portfolio of securities, you won't have to pay any taxes on distributions. You only pay taxes on any capital gains you realize when you sell the ETN. Naturally, this can also boost returns for long-term holders.

Performance

Let us now see how BCM performed so far. Because of the fact there is no tracking error with ETNs, it'd be a good start to see how close its performance is to the performance of the index it tracks.

In the last 10 years, the ETN returned a total of 13% while the index increased by 21.31%. It may be too early to call it but the ETN isn't very successful in replicating the performance of the index so far.

Now, let us compare BCM's performance to that of two other ETNs, also issued by Barclays:

BCM outperformed both iPath Bloomberg Commodity TR ETN ( DJP ) and iPath S&P GSCI TR ETN ( GSP ) by a wide margin. While BCM returned 4.47% in the last 10 years, the prices of DJP and GSP decreased by 21.54% and 38.93%, respectively.

And while I think that the above comparison is the most relevant, it would be interesting to also examine how some commodity ETFs performed against BCM:

Since the inception of iShares GSCI Commodity Dynamic Roll Strategy ETF ( COMT ), which is the youngest of the three securities compared, BCM has grown by 21.89%. In contrast, COMT and the United States Commodity Index ETF ( USCI ) have significantly underperformed, with COMT's price increasing by 2.47% and USCI decreasing by 1.72%.

I believe that even if the performance margin between BCM and its benchmark becomes wider because of fees and other factors, the advantages that come with an ETN structure will continue to provide better returns than ETFs in the commodity area. With that being said, the one who will benefit the most is the one committed to holding BCM for the long term. For speculating on commodity prices, ETFs are superior here.

Fees

BCM has an expense ratio of 0.6% and an annual futures execution cost of 0.1%. Though there are plenty of commodity ETFs with lower fees, I do believe that BCM's fees are reasonable. Besides the fact that it's the only one tracking the index it tries to replicate, the taxes one could theoretically save by buying and holding an ETN could actually make cheaper ETFs look more expensive.

In any case, when including the futures execution cost, BCM has the same fees as the two ETNs we compared it to above. Both DJP and GSP have an annual expense ratio of 0.7%. And when viewed in the context of historical performance, BCM's fees are even more than reasonable.

Risks

Last but not least, you should consider some risks specific to BCM because of its ETN structure. They are listed below in order of importance:

Call Risk : ETNs are callable debt securities and this creates a risk for capital loss if done at an unfavorable time for an investor. With that being said, I should note that Barclays has issued a great number of ETNs since 2006 of which only one has been recently called near the end of 2022, after about 17 years. For this reason, while I think we should be aware of this risk, it doesn't seem to be a cause for great concern for long-term investors.

Credit Risk : Unlike ETFs, an ETN has credit risk and is as safe as the issuer can remain solvent.

Issuance and Liquidity Risk : ETN issuers are not required to issue or redeem notes. If the issuer suspends such activities ( as Barclays did about a year ago), this can have an adverse effect on performance. However, I think this risk is not so relevant to the long-term investor as long as they are not psychologically affected by it.

For the full list of risks, take a look at the relevant prospectus .

Verdict

In conclusion, I believe you can't go wrong with BCM if you're a long-term investor looking for both exposure to the commodity markets and the best chance at the highest returns such exposure can offer.

As you saw, BCM looks better than both closely related ETNs and ETFs when it comes to performance. In addition, the potential value here makes the seemingly high fees not as significant and I wouldn't select any other vehicle for exposure to commodity prices even if they charged half the net expense ratio BCM does.

However, I will make it clear that my bullish rating on this ETN is in the context of a buy-and-hold approach. For speculators, I think BCM isn't such a good option.

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